tag:blogger.com,1999:blog-29593611131874750982017-09-24T00:01:39.446-04:00Autos and Economics<u><b>Mike Smitka</b></u> has followed the industry (and the Japanese economy) for 30+ years. <u><b>David Ruggles</b></u> has worked in every phase of the retail side: new and used, sales and management, and consulting in both the US and Japan. Go <a href="http://smitka.academic.wlu.edu">here</a> for links to Smitka's course blogs and research.Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.comBlogger339125AutosAndEconomicshttps://feedburner.google.comtag:blogger.com,1999:blog-2959361113187475098.post-37613236162725720832017-09-17T21:40:00.000-04:002017-09-17T21:40:51.938-04:00Autos can't live without China<p class="signature">mike smitka</p><p class="base">I take part in an online discussion forum on Japan that occasionally strays into economics and business topics. One ongoing thread is the potential impact of erecting a "bamboo curtain" around China. A couple posts assert that realigning global production following the elimination of trade with China would not be a big deal. They seem to forget the havoc caused by 3/11 (the Japanese tsunami/earthquake), where damage to a mere two plants impeded global automotive production. One produced a dye essential for certain black/red paints. Red isn't all that popular in most markets, but surely the firms that used it for black lost sales to rival manufacturers who had a different pigment mix. <span class="aside">[You don't substitute a different pigment without lots of testing – it's finicky, and the pigment layer may be only 19 microns deep. A different particle size or stickiness and you get paint that looks bad or worse, doesn't adhere. BMW owners won't tolerate peeling paint!]</span> Then there was the Renasas plant in Sendai, which was already in the process of shutting down. Work on their new plant in Southeast Asia was accelerated, and round-the-clock teams worked as well to restart production in Japan. Fortunately there were pretty big inventories and the processor involved was used in more than one function. It did mean certain option packages weren't available, but by so China however would not be just two plants.</p><p class="callout">...without a global market, it would make much less sense for European, Japanese and Chinese suppliers to set up shop in Detroit...</p><p class="base">The quick mistake is looking at the name on the front of the building, and assuming that what could be done by a company in one place could readily and quickly be done by the same company elsewhere. Foxconn, which assembles a big slice of the world's cell phones in Shenzhen in Southern China may for example be a Taiwanese firm, but local operations are very much Chinese. Foxconn does have factories in many parts of the world, but they are not making the same things. Ditto Corning (cell phone glass) and so on. Take down China, you take down everything.</p> <p class="base">To dig deeper, I provide two examples. One is of cell phones. The other is an extended discussion of the role of China in the global automotive industry. As what I have below is already long for a blog post, and quite frankly it's time to get back to class preparation, I don't provide any numbers for automotive trade. You can find more data and more detail in the China chapter of my recent book, Smitka & Warrian, <i>The Global Auto Industry: Technology and Dynamics</i>, up on Amazon on January 1st. See the link at the top of the right-hand column: as an eBook it's a mere $9.99.</p> <p class="base">In the case of cell phone production, there’s no place in the US where you could hire 50,000 workers in short order, much less the 100,000+ that Foxconn employs in Shenzhen. We do not have a thousand-plus experienced production engineers and foremen and quality managers and logistics experts and purchasing managers who could be dropped into one place. No other country does, either. We do not have firms that can supply, modify and repair the specialized capital equipment. There are components made only in China, and others that flit back and forth across borders – chip/sensor packaging isn’t necessarily in the same country as either the “fab” or the circuit board assembler. Of course there are also many management systems involved, including how to keep Samsung and Apple from seeing or even hearing rumors about each other’s prototypes. It’s Foxconn that knows how to tweak Apple’s design for volume production, and that has the "creative destruction" (= prototype testing) facilities. It’s not just a bunch of low-skill workers.</p> <p class="base">That’s even more true of the 山寨机 guerilla cell phone industry. The market for niche cell phones involves a network of small companies and finance specialists, where one company can come up with an idea for a phone. An example is putting two SIM cards in a phone instead of one, not a big deal in the US, but it's important in many countries where different carriers have different service areas, and for people who cross borders frequently. So in the background it's necessary to have close ties to wholesalers who ask for something of that sort. A design house can handle the case, specialist firms tweak the circuitry, others do the software patches, other source the parts and components, and finally a job shop assembles the phones. Of course there’s finance involved, lending to such firms – except for the assembler, none may have as much as a dozen employees – is again on the basis of relational capital. It took years for this network to evolve. Pull out a piece and you have nothing. Now that’s a China-based industry, but it should convey the level of sophistication on the China end of things. <p class="base">For the automotive case, the <a href="https://japanforum.nbr.org/scripts/wa.exe?A0=LIST">posts on the NBR Forum</a> included lists of several global components manufacturers, with the implicit assumption that they had cookie-cutter plants in several locations. Sometimes that's the case, though if China is a big piece of the global automotive pie, there may not be enough capacity. Such plants, though, are no longer the core of what's done in China. Three different strategies governed the entrance of global suppliers into China. Let's work through them.</p> <p class="base">First, some were “simple” branch plants, which suppliers started building in numbers in the late 1990s, such as for wire harnesses or aftermarket parts or other relatively unsophisticated components. (Caution: what was unsophisticated in 1990 may be a high-tech part today!) This business strategy sought to save on labor costs and export all production. For such technologies there are often only modest economies of scale, and plants are scattered in a number of countries. For wire harnesses more are in the Philippines than China, but some production remains in Mexico. (None in the US, except for low-volume high-voltage harnesses and small-lot production for pre-production vehicles.) Assuming a location with an adequate labor force could be located – such plants quite often employ thousands, and need a hundred or more supervisors and assorted other skilled managers – production could be shifted in a few months. But in the interim automotive production would drop to zero, and for some time quality would remain low. But hey, who needs windows that roll up and not just down, or a transmission that shifts properly?</p> <p class="base">Second, another pattern was to serve as a regional supply base, but with excess capacity for what in the early 2000s were the bigger markets of the EU and NAFTA. In one particular case with which I'm personally familiar, the capital equipment and top supervisors were from Germany, but there task was to replicate a plant in Virginia (which happened to be the company’s first location for a new high-tech component). Such production in China might not be much affected by US policy, assuming they could continue to import certain components. If there was a supply crunch, it would initially be production in Thailand, Korea and Japan that would shut down. But that would be awkward for a global supplier, so surely a portion of what remained of their global production capacity would be redirected from the US to keep them running, at the expense of producers in the US. </p> <p class="base">Now in this case there was initially no particular human capital on the Chinese end, but physically moving the equipment and then getting a plant up and running again would take 9 months to a year (that's what it took to set it up in China in the first instance). Of course depending on the legal framework – there was no legal mandate for joint ventures for automotive components, but many firms chose that route – their joint venture partner might not let them ship out the capital equipment, and the Chinese government would surely discourage such, even if you could get paperwork on the US end to permit transiting the bamboo curtain. In that case, ordering new equipment and tweaking the line to get it running would take much, much longer. My sense is that it would prove impossible to do in under 3 years, because of the backlog that would arise as everyone tried to place orders simultaneously. And it might take longer – much of the underlying tool and die capacity is now in China (both machines and skilled tradesmen). In any case, when there are only two-three global plants supplying a particular component for global gasoline engines programs, there would be massive disruption. And for things such as fuel injectors or valves or bearings, engines are designed around a particular firm’s component – no double-sourcing, so the engine would have to be modified to use a rival’s fuel injector or similar component, and then re-certified. But by and large rivals have similar footprints in China, so there’d be no workaround in going to another European/American/Japanese firm.</p> <p class="base">The third pattern is now the most important. China is the world’s biggest auto market (25 million units of light vehicles, more than either the EU or NAFTA). Many models launch first in China or are variations specific to China, and 40% of sales inside China are of vehicles engineered and assembled by domestic Chinese firms, not “global cars” from VW, GM (the two biggest car firms in China) and other foreign auto companies. To serve these customers, Chinese and otherwise, global suppliers have significant operations in China. Three very large global suppliers ($8-$20 billion sales) I’ve visited recently now have major engineering centers in Shanghai that are part of their core global R&D operations. Over the past decade all three have shifted towards local specialization. As very large firms, each has a dozen-plus R&D centers, located in at least a half-dozen countries. At one time they'd each do a little bit of lots of things. Now each center focuses on a specific component or technology as a "global center of excellence". As a reflection of that strategy, R&D in Shanghai is integral to global operations. Indeed, one of these firms (quietly) moved divisional HQ operations there, too, planned over a number of years to coincide with the retirement of several key people in the home country. First the senior person worked in Shanghai for a couple years, and then his designated Chinese successor worked at divisional HQ in the home country for a couple years, with others less senior moving back and forth for shorter stays (6 months or more) over a period of years. To repeat, it took years to set up a new R&D center, to build a team who could work with each other and with the rest of the global enterprise.</p> <p class="base">One driver for this particular firm was the ability to hire engineers in China. Another, though, was that China was the division’s largest and most profitable market. Indeed, today GM’s main engineering center in Asia is at PATAC in Shanghai, with over 2000 engineers and 15-plus years effort at building up teams (subcompacts continued to be done by Daewoo in Korea, but more and more of the next larger platform is done in China, not just the "top hat"). With GM’s sale of their European operations (Opel/Vauxhall) to PSA, Shanghai is now central to GM’s ability to design vehicles (again, platforms, and not just “top hats” for the Chinese market). To my knowledge other firms (eg, VW) are less China-heavy in their engineering, particularly the Japanese and Korean firms, but all have major operations there.</p> <p class="base">In sum, the auto industry is today tightly integrated on a global basis. You can’t pull out one piece from any of the 3 major centers (NAFTA, EU, China/Japan/Korea), and major suppliers typically have additional pieces of their global R&D footprint in Southeast Asia, India and Brazil. Factories are not mobile, engineering centers less so. Building a bamboo curtain between the US and China would shut down the US industry, and not just for months. It would be particularly ironic in that a couple initial studies suggest that the role of Detroit as a global engineering center is increasing – it’s no longer just a regional NAFTA role. That includes Chinese suppliers locating R&D centers in Michigan (I’ve visited one). Of course I’ve also visited factories in the US that ship a significant part of their output to China. Without a global market, it would make much less sense for European, Japanese and Chinese suppliers to set up shop in Detroit.</p> <p class="base">But it would be a huge hit to many industries, not just autos. It wouldn’t make America great again, and if the impetus came from the Washington, it would lead global firms to not put anything of value in the US.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/HXtpGoZV0f0" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/09/autos-cant-live-without-china.htmltag:blogger.com,1999:blog-2959361113187475098.post-68995647783702132162017-09-14T13:30:00.001-04:002017-09-14T13:30:27.168-04:00Sugar tariffs<p class="signature">Mike Smitka<br />reposted from my <a href="http://econ102.academic.wlu.edu/">Econ 102 Macro Principles</a> blog <p class="base">First, here are data to help you remember that import prices are not everything. Prices effectively triple between the wholesale price sugar farmers such as the Fanjul brothers receive, and the price you pay in a store. A big baker will pay something much closer to the wholesale than the retail price - if you buy by the train car (not the truckload!), delivery costs per pound are very low. The price gap between Brazilian and US sugar is about 40%. So even if the tariff was eliminated, the price would only fall by about 6¢ wholesale, and by about the same retail. How eager would consumers be to fight over 6¢ per pound? Even though I do some baking, it takes me over 1 year to use a 5 lb bag!</p><table width="400px" style="font-size: 0.8em;line-height: 1em;padding: 0"><tr><td>Prices</td><td>1980's Average</td><td>2013</td></tr><tr><td>Brazil Raw Sugar Price</td><td> - </td><td>14 cents</td></tr><tr><td>U.S. Raw Sugar Price</td><td>22.16 cents</td><td>20.46 cents</td></tr><tr><td>US Wholesale Refined Sugar Price</td><td>27.06 cents</td><td>27.22 cents</td></tr><tr><td>Grocery Store Refined Sugar Price</td><td>33.59 cents</td><td>64.32 cents</td></tr></table><p class="dblin">Source: <a href="https://sugaralliance.org/us-sugar-prices">US Sugar Prices - American Sugar Alliance</a>, <a href="http://www.indexmundi.com/commodities/?commodity=sugar&amp;months=60&amp;currency=brl">IndexMundi</a> for the Brazil price and <a href="http://www.xe.com/currencyconverter/convert/?Amount=1&amp;From=BRL&amp;To=USD">XE.com</a> for the Brazilian Real / US$ exchange rate.</p><p class="base">Then there is the political economy. The first sugar tariff dates to 1789. Protection was strengthened during the Great Depression with the 1934 Sugar Act, including policies to raise farmer's incomes while at the same time using rationing (esp during WWII) to avoid raising consumer prices. That Act expired in 1974, but in view of his pending election campaign President Ford tripled the import tariff. Presidents Reagan, and George HW Bush also implemented protective measures, while George H Bush was able to veto the Farm Bill in 2008 knowing that Congress would (did!) override his veto. Both Carter (a farmer!) and Clinton (who grew up in a farm district) turned down policies that would have increased sugar protection. There were no changes under Obama. <span class="aside">See the <a href="http://sugarreform.org/why-reform/history-of-the-sugar-program/">Coalition for Sugar Reform</a> for details.</span></p><p class="base">In both the EU and the US the sugar that you buy in a store or get in a restaurant sugar packet is beet sugar. Production dates to the 19th century, when new cultivars with higher sugar content made it a profitable crop, first in Europe and then in the US. In Japan sugar beets were cultivated in the 19th century, but then the expansion of the Empire southward to Taiwan (1895) led to more sugar cane. Today 2/3rds of Japan's sugar is imported, and there remains enough near-tropical land that 20% of domestic output is from sugar cane. Sugar beets are still the overwhelming domestic source. Oh, and that's because of tariffs in all 3 regions.</p><p class="base">Sugar growers are a powerful lobby. The Fanjul brothers own over 150,000 acres of Palm Beach County, Florida. That's a potential swing state in national elections (do you know the term "hanging chad"?). Both are politically active – one a Republican, the other not by chance a Democrat. In the Midwest corn farmers are a potent lobby, and in a handful of states so are sugar beet growers. The Senate thus has a big block in favor of agricultural protection. This political economy – enough farmers in enough electoral districts that their vote is essential – is true in Japan, the European Union and NAFTA. In the former two, unless I'm mistaken, direct and indirect farm subsidies are greater than aggregate farm income. The CAP (Common Agricultural Policy) is the single biggest item in the EU budget. Through the good fortune of geography agriculture in the US is inherently more productive, so our overall subsidies are less. It is nevertheless the sector where trade is most constrained by a web of quotas, tariffs, subsidies, cropping restrictions, loan programs and tax breaks.</p><p class="callout">...trade in sugar could have sweetened the Doha Round...</p><p class="base">This matters not just because it was a barrier to the continued integration of the European economies – agriculture has been the biggest sticking point in the various EU expansions, and with attempts to create greater policy cohesion among existing members. On the global trade front, the Doha Round was intended to extend the <a href="https://en.wikipedia.org/wiki/World_Trade_Organization">WTO</a> to cover agriculture, which largely left the sector untouched, other than requesting countries adopt tariffs in place of quotas. [See the textbook for why tariffs are far the better means of protection.] But the politics – dispersed consumers but a geographically concentrated industry, big enough to affect a significant minority of electoral districts in every high-income economy – meant no progress was made. Without progress, however, there was little "benefit" for negotiators from developing countries to take home. The talks have effectively collapsed, and there is no near-term ability to renew them.</p><p class="callout">...comparative advantage implies we benefit from unilaterally making importing easier...</p><p class="base">One real challenge is that several large developing countries are themselves facing pressure to subsidize farmers. China may not be a democracy, but the majority of urban residents have close relatives back on the farm. Keeping urban areas quiet requires making life better in the countryside. Most Chinese farmers now receive cash subsidies. Ten years ago they might have gladly offered many "concessions" to the US and Europe and Japan in agriculture. Now that dynamic is changing. We all lose. Comparative advantage implies we benefit from unilaterally making importing easier. That includes agricultural products. If we're concerned with issues of urban poverty, as is the case now in China, then agricultural imports are particularly beneficial. But because of the politics of "reciprocity," the agricultural sector impedes continued global negotiations. That would be fine if we could rest on our laurels. However, economies are not static, and so areas where all would benefit (healthcare-related sectors, under the rubric of "intellectual property") cannot be addressed because the horse-trading, multilateral most-favored-nation process of global trade negotiations has fallen under the weight of agricultural lobbies. The very real fear is that trade deals are like bicycles: unless they keep moving forward, they fall over and retrogress. Trade in sugar could have sweetened the Doha Round. Politics nixed that.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/cc0WHsNopig" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/09/sugar-tariffs.htmltag:blogger.com,1999:blog-2959361113187475098.post-39649554113015324032017-09-05T21:15:00.002-04:002017-09-05T21:20:07.711-04:00Automotive Employment Decomposed: New vs Used Car Dealers<div class="signature">Mike Smitka</div><div class="callout">...employments is centered in new car dealers and parts manufacturers...</div><div class="separator" style="clear: both; text-align: center;"><a href="https://4.bp.blogspot.com/--XcpdylxK4Q/Wa9KkGrxfxI/AAAAAAAABF0/obJRfqCWbY8tKKJr7vV_NlFvi-LZ5hH1ACLcBGAs/s1600/New%2Bvs%2BUsed.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="1034" data-original-width="1425" height="290" src="https://4.bp.blogspot.com/--XcpdylxK4Q/Wa9KkGrxfxI/AAAAAAAABF0/obJRfqCWbY8tKKJr7vV_NlFvi-LZ5hH1ACLcBGAs/s400/New%2Bvs%2BUsed.png" width="400" /></a></div><p class="base"><a href="https://4.bp.blogspot.com/-CjPFkVJ4DAk/Wa9KqbQIBpI/AAAAAAAABF4/3jSSs_STHL8nA6GoS2OkCDmbX2w5VhCjACLcBGAs/s1600/AutoRetail.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="1033" data-original-width="1424" src="https://4.bp.blogspot.com/-CjPFkVJ4DAk/Wa9KqbQIBpI/AAAAAAAABF4/3jSSs_STHL8nA6GoS2OkCDmbX2w5VhCjACLcBGAs/s400/AutoRetail.png" width="217" /></a>Scott Wood of Carvana asked me about the increase in employment in automotive retail. With a bit of poking, I found that the Current Employment Survey (CES) run by the BLS provides fairly detailed breakdowns. Now I very strongly suspect that in the survey responses, employees at a new car dealer are not subdivided into those who work in service vs finance vs new sales vs used sales. All are likely classed by the main&nbsp; business category of new car sales. Still, this provides a starting point. As it happens, while used car dealership employees have risen faster, the bulk of the increase in employment stems from the rise in new car dealership employees. While I'm at it, I also am posting (i) car vs parts/accessories/tires and (ii) assembly vs parts manufacturing. As expected – well, at least by me! – people who work in parts plants vastly outnumber those at "the" car companies. The latter get the political attention, but they're not the ones who "make" cars, they just put together the pieces.<br /><div class="separator" style="clear: both; text-align: center;"><a href="https://2.bp.blogspot.com/-PRMVUojBs64/Wa9Kqdjk7_I/AAAAAAAABGA/y7KtAJdHBeY0KcfRJMGts6-2EZnifUS4wCPcBGAYYCw/s1600/Parts-Assembly.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1034" data-original-width="1425" height="290" src="https://2.bp.blogspot.com/-PRMVUojBs64/Wa9Kqdjk7_I/AAAAAAAABGA/y7KtAJdHBeY0KcfRJMGts6-2EZnifUS4wCPcBGAYYCw/s400/Parts-Assembly.png" width="400" /></a></div></p><div class="separator" style="clear: both; text-align: center;"><a href="https://3.bp.blogspot.com/-PRMVUojBs64/Wa9Kqdjk7_I/AAAAAAAABF8/mE7hqOr38bkwaN38Dz8OHks35jtWYnb_ACLcBGAs/s1600/Parts-Assembly.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><br /></a></div><div class="separator" style="clear: both; text-align: center;"><a href="https://4.bp.blogspot.com/-CjPFkVJ4DAk/Wa9KqbQIBpI/AAAAAAAABF4/3jSSs_STHL8nA6GoS2OkCDmbX2w5VhCjACLcBGAs/s1600/AutoRetail.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><br /></a></div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/ijNNPV7xkiM" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/09/automotive-employment-decomposed-new-vs.htmltag:blogger.com,1999:blog-2959361113187475098.post-70801393316391662812017-09-03T10:17:00.000-04:002017-09-03T10:17:29.681-04:00Quick Update: US Labor Force Graphs, including autos<p class="signature">Mike Smitka</p><a href="https://2.bp.blogspot.com/-8GFS6bHbuoY/WawKsx7RatI/AAAAAAAABFM/Y08UioYnnLwVdVdRJ0d08r46DMJiRTceQCLcBGAs/s1600/U6.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="959" data-original-width="1409" height="218" src="https://2.bp.blogspot.com/-8GFS6bHbuoY/WawKsx7RatI/AAAAAAAABFM/Y08UioYnnLwVdVdRJ0d08r46DMJiRTceQCLcBGAs/s320/U6.png" width="320" /></a><p class="base">Here is an overview of (i) unemployment across the Great Recession and the subsequent recovery, highlighting U-6 "total pain" versus U-3 "headline unemployment." U-6 peaked at 17% of the labor force. It doesn't reflect those who dropped out but weren't "discouraged" or "marginally attached" by the BLS – currently, as per the graph below, that's still about 2% of prime-age workers, and 4% for age 20-24 workers. See the graph on the right for details.</p><p class="base">I also calculated a "normal" level of total employment, using the relatively constant age-specific rates in the period prior to 2007, but adjusting the total for demographic changes, particularly "boomer" retirement. That's the graph immediately below. By that measure we're still a year away from "full" employment, assuming no slowdown. We have however added 12.2 million jobs, relative to population growth, since the trough of the Great Recession.</p><a href="https://4.bp.blogspot.com/-0cRneObYIKw/WawLzxSPoII/AAAAAAAABFc/0Ds0mELMrN8rpLzeHfax6R4qwXuTfACdQCLcBGAs/s1600/Participation.png" imageanchor="1" style="clear: right; float: right;"><img border="0" src="https://4.bp.blogspot.com/-0cRneObYIKw/WawLzxSPoII/AAAAAAAABFc/0Ds0mELMrN8rpLzeHfax6R4qwXuTfACdQCLcBGAs/s320/Participation.png" width="320" height="218" data-original-width="1409" data-original-height="959" /></a><p class="base">Finally there's the auto industry. On the retail side employment is at a historic high. However on the manufacturing side, despite robust domestic production, the industry employs about 130,000 fewer workers than at the onset of the Great Recession, or about 12% fewer. That is, one in eight jobs vanished. Why? – productivity. This reflects a long-term trend, it simply takes fewer people to turn out a vehicle today than in 2006, primarily due to more efficient parts production, because that's the sector where nearly 3 out of 4 workers in vehicle manufacturing are located.</p><a href="https://3.bp.blogspot.com/-SohVW1yh1XY/WawKtZdIZmI/AAAAAAAABFQ/U22l4CJh10sEg0O1otIWvHnrlxHYFo9RwCLcBGAs/s1600/ShortHours.png" imageanchor="1"><img border="0" data-original-height="957" data-original-width="1408" height="218" src="https://3.bp.blogspot.com/-SohVW1yh1XY/WawKtZdIZmI/AAAAAAAABFQ/U22l4CJh10sEg0O1otIWvHnrlxHYFo9RwCLcBGAs/s320/ShortHours.png" width="320" /></a> <a href="https://4.bp.blogspot.com/-gPcqE6dj94A/WawKs-mqM_I/AAAAAAAABFI/M1xph2cO6XQGmid3uFqbvakIm3FpX2KVQCLcBGAs/s1600/AutoRecovery.png" imageanchor="1"><img border="0" data-original-height="1034" data-original-width="1426" height="232" src="https://4.bp.blogspot.com/-gPcqE6dj94A/WawKs-mqM_I/AAAAAAAABFI/M1xph2cO6XQGmid3uFqbvakIm3FpX2KVQCLcBGAs/s320/AutoRecovery.png" width="320" /></a><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/LfSP_g8al-A" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/09/quick-update-us-labor-force-graphs.htmltag:blogger.com,1999:blog-2959361113187475098.post-61897963801521461522017-08-27T20:42:00.001-04:002017-08-31T15:27:29.475-04:00Harvey to clear the industry's excess inventory<p class="signature">Mike Smitka</p><p class="callout">...the Thu 31 Aug Automotive News morning 'cast gives 300K-500K vehicles, but unfortunately the storm lingers...I hope I am wrong on the 1 million figure...</p><p class="base">Harvey will cost insurers billions. Part of that will go towards the purchase of replacement vehicles. Macabre, yes, but that's a timely bump for an industry that has been grappling with excess inventory. Houston proper has 2 million people, and extend out to Harris County and you have almost 4.6 million. Immediately adjacent counties add 1.2 million more. At present the cars of a significant slice of that population are underwater, and will remain so for another day or more. That means they're totaled. Across Texas as a whole that certainly means 1.0 million vehicles, and perhaps more. A week ago the industry was awash with excess industry. Now it's not.</p><p class="callout">...for the auto industry Harvey is not a disaster but a turn of good fortune...</p><div class="separator" style="clear: both; text-align: center;"><a href="https://s2.reutersmedia.net/resources/r/?m=02&d=20170827&t=2&i=1198776578&r=LYNXNPED7Q0OE&w=940" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://s2.reutersmedia.net/resources/r/?m=02&d=20170827&t=2&i=1198776578&r=LYNXNPED7Q0OE&w=940" width="320" height="212" data-original-width="800" data-original-height="529" /></a></div><p class="base">As sales fell over the past 9 months, the US industry built up inventory. A healthy level is around 60 days of sales. But by June 2017 dealers had 74 days worth of cars and light trucks on their lots, and pared that level only modestly to <a href="http://wardsauto.com/datasheet/us-light-vehicle-inventory-summary-july-2017">[Ward's]</a> 69 days in July, or <a href="http://gmauthority.com/blog/2017/07/gm-inventory-increases-39-percent-to-almost-1million-units-in-july-2017/">4.2 million units</a>. Of course this hides significant variation, with GM holding 104 days (0.98 million units) and Ford 76, while Subaru had only 40. Now much of the excess is in sedans, as demand shifted towards light trucks – the latter sold at a 10.8 million unit rate in June, while sedans sold at only a 5.8 million rate. The industry is responding: over the past year, NAFTA light truck production was<a href="http://wardsauto.com/datasheet/north-america-production-summary-july-2017"> [Ward's]</a> up 4%, sedan production down 11%. That won't be reversed in the short run – suppliers can't spew out extra parts overnight – so sedan inventories were already set to keep falling.</p><p class="base">Now Texas is truck country, as <a href="http://www.cnn.com/videos/us/2017/08/27/harvey-houston-flood-dickinson-ed-lavandera-boat-tour-sot-nr.cnn">CNN's videos of Houston neighborhoods</a> indicate. So Harvey won't be as big a boon for sedan sales, though Texans who find they're underwater on their loans may be forced to downsize to a mere car. The impact remains: 1.0 million units represents 16 days sales, and will help the industry draw down inventories to closer to 50 days. For the auto industry Harvey is thus not a disaster, but a turn of good fortune.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eSzX" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eSzX" width="320" height="123" data-original-width="800" data-original-height="308" /></a></div><p class="aside">The US Bureau of the Census tracks the <a href="https://fred.stlouisfed.org/series/I4231IM144SCEN">dollar value</a> of automotive retail inventories. The most recent data – $68 billion in June 2017 – do not separate detail new versus used vehicles, or parts and tires versus vehicles. In contrast, the biggest purely retail sector, drugs and druggist sundries, comes to only $60 billion.</p> <img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/DWk1PFm8g4Y" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/08/inventory-cycle-cycled-harvey.htmltag:blogger.com,1999:blog-2959361113187475098.post-1985972038568594512017-08-19T12:09:00.000-04:002017-08-19T12:22:27.501-04:00Auto Inventory Cycle Adjustment: More Pain Ahead<p class="signature">Mike Smitka<br />Washington and Lee University</p><p class="base"><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5p" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="308" data-original-width="800" height="122" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5p" width="320" /></a>During the extended housing boom of the early 2000s, consumers used home equity lines to go on a consumption binge. Light vehicle sales remained strong, while the model mix richened. Then the housing bubble reached its peak (and gas prices rose). The good times were over, and at the February 2009 trough sales fell to that of the trough of the 1981 recession. In relative terms the situation was far worse, because in the interim the US population grew by almost 80 million. Relative to employment, sales were a full 15% below the previous post-1976 (before which consistent data are unavailable).</p><div class="separator" style="clear: both; text-align: center;"><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5r" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em; text-align: center;"><img border="0" data-original-height="308" data-original-width="800" height="122" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5r" width="320" /></a></div><p class="base">Cars are durable goods, and even though the average vehicle now lasts 12 years, they eventually need to be replaced. Meanwhile the US population continues to increase and incomes have recovered (though for most Americans, not risen). From an excess of vehicles per household going into the recession, the number fell below what households wanted, and has now recovered. In February 2007 SAAR was 16.7 million units; that level wasn't hit again until March 2014. Fueled by low interest rates, longer loan maturities, and high used vehicle prices, sales crept back up. Indeed, <a href="https://www.chicagofed.org/people/t/traub-paul">Paul Traub</a> of the Federal Reserve Bank of Chicago argues that they have been higher than sustainable.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://3.bp.blogspot.com/-TKqVZ5rSxDc/WZhZVMA9wdI/AAAAAAAABEw/0R0zWiPEEj45-cKu8MyZMemzXtgzqUsOACLcBGAs/s1600/inventory.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="757" data-original-width="1023" height="158" src="https://3.bp.blogspot.com/-TKqVZ5rSxDc/WZhZVMA9wdI/AAAAAAAABEw/0R0zWiPEEj45-cKu8MyZMemzXtgzqUsOACLcBGAs/s320/inventory.png" width="280" /></a></div><p class="callout">...it's payback time...</p><p class="base">It's payback time. Over the past several months the Light Vehicle SAAR (seasonally adjusted annual rate of sales) fell 7.5% from its December 2016 peak of 18.051 million units. This represents a drop of over 1 million units. Now &nbsp;inventories rise and fall as a normal response to short-term swings in sales. With a steady fall, though, they mushroom, and mushroom they have. <span class="aside">(Thanks to Paul and his May 2017 presentation to my W&L auto seminar for the graph on the left.)</span> Now that the drop appears to be more than a transitory blip, it's time to bring inventories under control and pare production.</p><p class="callout">The supply chain is like a snake....</p><p class="base">The supply chain is like a snake. If it's to eat bigger prey, it has to bulk up, and that takes time as suppliers rehire and otherwise add capacity. (This is on top of the normal investment to replace tooling for old models with that for new. Given the hit balance sheets took from the Great Recession, they also had to repair balance sheets to add capacity.) Going into the recession, production peaked in June 2007. It took over 6 years, until November 2013, to reach the previous peak.</p><div><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5d" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em; text-align: center;"><img border="0" data-original-height="308" data-original-width="800" height="123" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO5d" width="320" /></a></div><p class="callout">....that's consumed too big a meal.</p><p class="base">Now it’s like a snake that’s just consumed too big a meal: it's sluggish, because it takes time to get it out of its system. The Production Index hit 131 in October 2016, and bounced around that level through April 2017. It’s since fallen 7.6%. But that at best brings production in line with sales. It doesn’t pare inventories. That will require either an uptick in sales (fueled by assorted incentives) or a further cut in output. GM for example has chosen the latter, with extended summer vacations – not that they aren’t discounting, after all they can’t totally ignore price cuts by competitors. Output will surely fall more; it’s better to overshoot a bit, given uncertainly about whether sales will fall further. And today labor is no longer a fixed cost. As per Econ 101, the flip side of higher marginal costs makes it relatively more profitable to cut production than prices.</p><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO53" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="308" data-original-width="800" height="123" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eO53" width="320" /></a><p class="base">That leaves two questions. One: what is the stable level of output? I’ll save that for another post; too many graphs already! The second is employment. Here the bottom line is clear: productivity continues to rise, a trend visible as far back as data are available. Industry employment is certain to fall, and on a permanent basis. As a dismal scientist, I close with that graph, and with that of auto industry manufacturing employment.</p><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=eIxh" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="308" data-original-width="800" height="246" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=eIxh"width="640" /></a><div class="dblin">I leave out many pieces. One is that while manufacturing productivity increased, that's much less true of automotive retail: employment there is at a historic peak. Then there are the finance, household formation, population data, household formation, depreciation and other pieces of the peak sales story that Paul Traub sets forth. I have not tried to put together the last couple months of inventory data, or compiled the various media reports of reduced production at GM factories, eg Lake Orion where the slow-selling compact Sonic (and the Chevy Bolt EV) are produced. Finally, while I can't provide any details, I do participate when my schedule permits in the monthly sales analysis roundtable that BWG hosts for their clients. My reading of these various sources is that at a more detailed level, some manufacturers are slower in responding than others, while the impact of the sales slowdown is uneven across manufacturers/brands, with for example the shift towards light trucks amplifying the impact on producers that are sedan-heavy, such as some of the Asian brands.</div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/NIvIsddOLuo" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/08/auto-inventory-cycle-adjustment-more.htmltag:blogger.com,1999:blog-2959361113187475098.post-24740359378548438932017-08-17T10:15:00.002-04:002017-08-17T10:15:55.492-04:00Real Yield Curve<p class="signature">Mike Smitka</p><p class="base">I look at data of various sorts, often out of mere curiosity. One ongoing puzzle is the evolution of interest rates. I've posted graphs of <i>nominal</i> rates, and implied future rates. Below are similar graphs for <i>real</i> rates, as calculated by Treasury using inflation-adjusted bond (TIPS) yields. The first are the real rates at various maturities. (That's the graph on the left – click to expand.) I then use the difference between yields at different maturities to calculate the implied future interest rate. (Duh, that's the graph on the right.)</p><div class="separator" style="clear: both; text-align: center;"><a href="https://4.bp.blogspot.com/-1vzBd0YZOYw/WZWQQA2g5ZI/AAAAAAAABEI/vh831-hgiUooU6nENtO7uWCsTIFRIovTgCPcBGAYYCw/s1600/RealYieldCurve.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" src="https://4.bp.blogspot.com/-1vzBd0YZOYw/WZWQQA2g5ZI/AAAAAAAABEI/vh831-hgiUooU6nENtO7uWCsTIFRIovTgCPcBGAYYCw/s320/RealYieldCurve.jpg" width="320" height="232" data-original-width="712" data-original-height="516" /></a></div><p class="base">At one level these look sensible. We see that longer maturities have higher yields. We see craziness in fall 2008. But real rates remain low, around 1% into the far future. They look sensible, but they don't make sense.</p><p class="callout">...[they] look sensible, but they don't make sense...</p><p class="base">One explanation might be global excess savings, what Ben Bernanke termed in 2005 as a <a href="https://www.federalreserve.gov/boarddocs/speeches/2005/200503102/">global savings glut</a>, driven by countries where individuals and firms are building up financial assets as their populations grow but where they've run out of sensible domestic investment possibilities. That requires financial outflows (and for that to happen, a trade surplus). And on the US end we do indeed see the flip side of trade deficits and net financial inflows. (Again, you can't have one without the other.)</p><p class="base">After all, conceptually the return on investment ought to be higher in labor-abundant, poor economies. But I find it hard to believe that story, when we find it going on year after year. OK, many economies have unstable politics, which might make would-be investors cautious. So savings could pile up. But we don't see sharp breaks that might be consistent with that story, that is, with the ebb and flow of politics. Indeed, if that sort of uncertainty is key, we ought to see a huge Trump bump, because politics in the US now looks zany. Policy change is precluded by political infighting and the failure to appoint staff across the Federal government. We have no ability to address a crisis, much less attend to long-run challenges such as putting in place a true healthcare system, improving eduction or setting our fiscal house in order. The bottom line is that I don't see any such effect in the data.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://3.bp.blogspot.com/-aARCpFwPArI/WZWTATQvttI/AAAAAAAABEc/5oZ-wTs8KlIxexwpfC4Djxu1CB9qwCQ-gCPcBGAYYCw/s1600/FutureReal.jpg" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://3.bp.blogspot.com/-aARCpFwPArI/WZWTATQvttI/AAAAAAAABEc/5oZ-wTs8KlIxexwpfC4Djxu1CB9qwCQ-gCPcBGAYYCw/s320/FutureReal.jpg" width="320" height="232" data-original-width="712" data-original-height="516" /></a></div><p class="base">The other story is secular stagnation: that despite the hype and self-promotion of Silicon Valley and the venture capital vultures who circle in search of easy feeds, there just isn't much happening. Cheaper taxi services – Uber, for example – just aren't working out. And from an economy-wide perspective it's hard to see an economic revolution in that, or better dating apps, or in receiving streams of 140 characters. In the $20 trillion dollar US economy, there's room for a lot of successful new $50 million businesses, but again, from a $20 trillion dollar perspective they are chump change. Robots? – I've been visiting factories for decades, automation is already widespread. The low-hanging fruit has been picked, and "hard" goods are only a 20% slice of our consumption. Artificial intelligence? The Executive Director of our small local United Way of Rockbridge worked in the earliest AI initiative at Stanford in the 1970s. Algorithms aren't new, and the cost of computing has long been near zero. Again, the low-hanging fruit has already been picked.</p><p class="callout">...the other story is secular stagnation...</p><p class="base">My preferred explanation then is that (to borrow the title of Marc Levinson's most recent book), the transport, information and energy revolutions that exploded after 1800 represented <a href="https://smile.amazon.com/Extraordinary-Time-Postwar-Ordinary-Economy/dp/0465061982/">An Extraordinary Time</a>. That era has now come to a close, and henceforth we will no longer see the productivity growth that underlay the rise of the US. To borrow again, this time from Robert Gordon, this represents <a href="https://smile.amazon.com/Rise-Fall-American-Growth-Princeton/dp/0691175802/">the Rise and Fall of American Growth</a>.</p><p class="base">However it's not just an American story, something emphasized more by Levinson than by Gordon. It's the story throughout the OECD economies, Europe and Japan and now even China. We can pray that in the next 3 decades South Asia and Africa converge on the developed economies through their own growth miracles. But for now they're too small, and too isolated financially, to offer a solution to the secular stagnation that we see in the US.</p><div class="dblin">Disclosure: I'm using Levinson's book this fall in my 2 sections of Econ 102, Principles of Macroeconomics. I listened to the <a href="https://smile.amazon.com/Extraordinary-Time-Postwar-Ordinary-Economy/dp/B01N0ARFSD/">Audible</a> recorded book version this spring, and am now reading the hard copy one. Gordon is also available as a recorded book, but given his prolific use of data, I can't imagine consuming it without his graphs in front of me – and I do my listening while driving.<br />For completeness, Bernanke reviewed his original savings glut story 10 years later, in a <a href="https://www.brookings.edu/blog/ben-bernanke/2015/04/01/why-are-interest-rates-so-low-part-3-the-global-savings-glut/">2015 Brookings post</a>. Here too is <a href="http://economics.weinberg.northwestern.edu/robert-gordon/files/RescPapers/DemiseUSEconGrowth.pdf">The Demise of U.S. Economic Growth</a>, a modest-length paper that covers the stagnation themes that appear in the latter 100 or so pages of Gordon's 750+ page book.</div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/s-WCdil-W98" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/08/real-yield-curve.htmltag:blogger.com,1999:blog-2959361113187475098.post-16772257672000690172017-08-10T12:53:00.000-04:002017-08-10T12:53:07.402-04:00Auto margins and disruptionJust a quick cross-reference in line with the previous post a great quote: <p class="dblin">“TSLA, for all Musk's gift-wrapping abilities, is primarily a manufacturer, and history has shown us that the economics of the automotive industry are crap. ” </p><p class="signature">Graham Osborn, Contributor 10 Aug 2017, 09:51 AM </p>found in the comments to "<a href="https://seekingalpha.com/article/4097058-thoughts-teslas-latest-bond-offering">Some Thoughts About Tesla's Latest Bond Offering</a>" posted by Montana Skeptic at Seeking Alpha on August 10th.<img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/-1LAk9y_tO4" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/08/auto-margins-and-disruption.htmltag:blogger.com,1999:blog-2959361113187475098.post-29871404388794499632017-08-02T00:04:00.004-04:002017-08-02T00:04:49.603-04:00No margins, no disruption: the New Mobility Challenge<p class="signature">Mike Smitka<br />Washington and Lee University</p><p class="base">If you want to disrupt an industry, you need to pick one with fat margins. That's the real challenge for the entire family of "new mobility" models, and more generally for "disruptive" technologies in the automotive footprint. It's one thing to be able to arbitrage regulated monopolies, which is what most incumbent cab companies are. But that only works if your strategy provides you with entry barriers, and the monopolies you break into earn piles of money. Local cab companies are however perfectly capable of developing their own cell phone apps, benefitting from the high ratio of "locals" in the customer base. That's true up and down the automotive value chain: all operate with thin margins. They are thus NOT ripe for "disruption."</p><p class="callout">...why would anyone want to try to disrupt a market with thin margins?...</p><p class="base">At base, motor vehicle manufacturing, distribution, repair, and the final market of transportation services have few monopolies. Yes, if you want to develop the next-generation diesel engine there are only two players who are capable of the underlying material science and have the ability to manufacture with the requisite quality in the requisite volumes. (These two are Federal Mogul and Mahle.) There are however multiple firms capable of "mature" piston production. The same is true for every other component that I can think of: there are often a small handful of "leading" firms but there are also commodity producers of older technologies. The only way to preserve margins is to keep innovating.</p><p class="base">Furthermore, it's a complex chain. Assembling vehicles, as Tesla is learning, is the easiest part – and they don't yet have their Model 3 assembly line up and running, despite having more employees than the normal volume assembly plant. But that's the tip of the iceberg: they have yet to solve the national distribution challenge in a cost-effective manner. Assuring that component supply lines can meet your production plan, and that you can take tradeins, provide financing and repair vehicles quickly, all that takes a lot of people and a lot of physical assets. Experience helps, too. If you're to grow rapidly, those have to be in place beforehand. Some resources can be borrowed, including the financing, as happens in the "traditional" franchised dealership system (though Tesla has decided not to do so).</p><p class="base">It took over a decade from their establishment of a solid footprint for Honda, Toyota and VW to succeed – and as VW has demonstrated, laurels can be lost. After all, in the early 1960s and again around 1968 VW was THE import market in the US. They're now barely a player. The VW vertically integrated, single model mass production strategy worked for a while, as did Henry Ford's monomaniacal focus on the Model T and nothing but the Model T. Neither VW nor Ford were ever able to lower costs sufficiently to develop a sustainable advantage against the evolving products of rivals. In contrast, Tesla is a high-cost producer with a high-cost distribution system. High costs aren't an insuperable barrier if you aim to break into the premium car segment, but even then you have to keep renewing your product. High costs don't work if you aim for the high volume, middle-segment of the market.</p><p class="base"> Ditto Uber on the downstream transportation service end: taking over the taxi business would be great, but only if the underlying business was unusually profitable. But it's not. There's little room for cost reduction – materials, labor, overhead. It's not as though existing taxis are new and drivers well-paid. There not much room to cut economic costs, even if in the short run costs can be shifted to unsuspecting parties (Uber's owner/driver contractors). The only way Uber can provide reliably better service than incumbent Yellow Cabs is to have higher peak load capacity, with the requisite assets of vehicles and drivers. Superior service at a comparable price lets them grab market share, but they've not expanded the market. And without a bigger market they can't sustain their high-cost strategy. A cell phone app doesn't lower the cost of a car, or lower the minimum wage paid by alternate jobs. To reiterate: creating a big taxi company does not provide a route to healthy long-run margins.</p><p class="callout">...creating a big taxi company does not provide a route to healthy long-run margins...</p><p class="base">So don't be fooled by the apparent ease of entry by disruptors. Yes, Tesla can draw upon the base of automotive suppliers to launch a car, something that would not have been possible in the more vertically integrated world of the 1960s. Numerous Chinese domestic players have done the same, and one or two may even survive if not thrive, the Geely's and Great Walls. But Tesla can't rapidly expand in the mature markets of NAFTA and the EU, absent a revolution in battery costs that decades of leading-edge chemistry research has yet to deliver. They can't compete in costs against the still-improving technology of the internal combustion engine. They can't compete by eroding the fat margins of incumbents, because margins aren't fat. <p class="base">Autonomy is much the same. The suite of sensors need to be integrated into a vehicle, software integrated into the actuation of steering, braking and so on. Everything then needs to be tested. Car companies are good at that – that's why they're called assemblers. Many of the pieces are already in place, but consumer acceptance is still uncertain, and the only way average transaction price can rise is if sales fall: the average new car purchaser can only finance so much, given stagnant incomes amidst a driving population that is virtually flat. In other words, implementing a costly technology won't help margins. Indeed, it's already gotten the CEO of Ford fired.</p><p class="callout">...govt policy can disrupt the (auto) market, but not Tesla, not Uber, not Waymo...</p><p class="base">There is one exception: government policy can disrupt the market, by enacting direct and indirect subsidies (such as California ZEV credits or safety mandates). But not Tesla, not Uber, and not Waymo. What is amazing is that, given automotive margins, they purport to have "disruption" as their strategy. It may work on the stock market, at least for a while. It won't work in the automotive market.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/1H814YDQEjk" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/08/no-margins-no-disruption-new-mobility.htmltag:blogger.com,1999:blog-2959361113187475098.post-3298953207165161572017-07-09T10:17:00.000-04:002017-07-09T10:41:50.257-04:00Germany will be first in EVs – but don't invest in VW!<p class="signature">Mike Smitka</p><p class="base">The first big market for EVs will be the EU, not China and certainly not the US. This is not common wisdom: after all, isn't Beijing pushing EV technology, including forcing firms to buy batteries from "domestic" players? And then there's Tesla in the US. Of course in terms of hype no one can beat Elon Musk (and in semiconductors, NVDIA). But against global production of 90+ million units Tesla's puny 80,000 units in 2016 is on the order of the reporting errors in global sales data. They aren't disrupting anything. Instead the disruptor will be VW, adding to the presence of Renault and Nissan.</p><p class="base">This was one of my key takeaways from the 25th <a href="gerpisa.org">GERPISA</a> conference in Paris in June, garnered across 4 days of R&D center visits, presentations and conversations. <span class="aside">[For fellow researchers, next year's GERPISA will meet in June in Sao Paulo Brasil.]</span></p><p class="base">On the regulatory side, EU fuel efficiency rules cinch tighter in 2020-21, and thanks in part to VW the test cycle standards – currently the New European Driving Cycle – will be tightened to better reflect actual EU driving patterns. (Currently, for example, back seats can be removed and the alternator disconnected, while accelerations are unrealistically slow and idles too frequent.) That will make it extremely difficult to meet CO2 mandates. Reconfiguring diesel systems that passed due to "cheats" will lower their efficiency and raise their costs. Keeping to a diesel-centric strategy won't work. This will be a particular challenge for VW. At the same time, France was already moving to limit the presence of diesels in urban areas.</p><p class="base">Hence BEVs (battery electric vehicles). VW just announced <a href="http://www.autonews.com/article/20170707/COPY01/307079924/why-vw-thinks-it-has-the-edge-over-tesla-with-evs">they've frozen the design of their first model</a>, to be launched in 2020, and will thereafter start turning over their fleet to BEV models. For now they are basing their model on the underlying architecture of the Gulf. However, they are working on new architectures that will facilitate flat battery packs – we at GERPISA visited Renault's vehicle competitive teardown facility, and that's one of the things they look for in their analysis of new platforms.</p><p class="base">Then there are batteries. VW will not make their own cells, reflecting both a lack of internal capabilities and to maintain the flexibility to shift their sourcing as cell technology advances. But they will make their own modules and packs, to better control weight and safety. Those are also heavy and bulky, so doing this in their assembly plants makes sense. Ditto <a href="https://electrek.co/2017/07/05/daimler-battery-factory-china-mercedes-benzs-electric-cars/">Daimler</a>.</p><p class="base">Now VW is not alone, even if their diesel-heavy strategy and legal issues places them in an awkward position. Renault continues to update the Clio (and Nissan the Leaf), and both are poised to launch additional vehicles in line with demand. Meanwhile, the various EU members are building out base infrastructure. France already has charging capabilities along major highways; Norway (a small market!) is already 30+% electric. The government role is central, because infrastructure is expensive, and needs to be pervasive. Private efforts suffer from chicken-and-egg issues. For-profit charging ventures inevitably focus on dense areas. But for consumers to make a BEV their sole vehicle, national availability helps: there's always that trip to the beach, or a quick weekend getaway to the countryside. Such locations wouldn't generate enough business to make it pay to set up charging, at least early in the rollout of BEVs. But their presence facilitates market expansion.</p><p class="base">After hearing pieces of this story from multiple people, I'm now convinced that BEVs will happen sooner than I expected in Europe. Key is that they will now provide a better value proposition relative to diesels, which intrinsically sip rather than gulp fuel. But batteries remain expensive, so that's not good news for VW. To meet efficiency standards they'll need to sell a lot of EVs. To do so on a competitive basis against the standard gasoline vehicles from other manufacturers means VW will lose money on each one it sells, to the tune of billions of euros as volumes rise. So VW has solved the subsidy dilemma: economies of scale and competitive costs can't be achieved without somehow getting BEV volumes up. EU incentives aren't enough; paying for a test fleet is one thing, doing it for millions of cars is another. VW incentives may well make the difference – indeed, Volkswagen is betting the company that that will be the case. In the interim, though, VW will not be particularly profitable. That interim will extent until 2027, at which point costs will fall, or VW will. Don't invest in VW!</p><p class="callout">...for the next 10 years, don't invest in VW...</p><p class="base">For the US, the current administration is hostile to environmental issues, and is promising to roll back fuel efficiency standards (which will benefit luxury car makers, primarily German, and hence is not particularly helpful to domestic manufacturing). At the same time, the current Congress seems unable to pass any legislation, much less focus on such long-run issues as energy policy. That may change over the next couple elections, but for the time being there will be no national infrastructure policy in the US, and without that BEVs will remain a niche product. Yes, the fines VW is paying will be used to build charging infrastructure, particularly in California. But there's no national vision behind it, only an attempt of VW to get some modest indirect benefit out of their fraud settlement.</p><p class="base">Then there's China. For the same budgetary reasons as elsewhere, Beijing will rein in central government subsidies by 2020. Yes, they want electric vehicles, they want to have a presence in new technologies. No, they don't want to pay for it. Economic nationalism fails as a policy when it requires spending serious money. Meanwhile Panasonic and others are building plants there, suggesting that a "Chinese companies first" stance will work no better there than it has in the passenger car market, where VW and GM are #1 and #2. In fact, China has already relaxed its stated limitations on foreign firms setting up new joint ventures: <a href="http://www.autonewschina.com/en/article.asp?id=16330">new ones are fine if they're for EVs</a>.</p><p class="callout">...China may be the largest single BEV market, but it lives on subsidies and those are fading...</p><p class="base">One presentation at GERPISA made that clear, using insurance data (not registration data, known to be misleading due to false registrations by various corrupt "car companies" that let them pocket government EV subsidies without actually making vehicles). As everywhere, BEVs are a small share of the market. Once the data were disaggregated geographically, it turns out that in many regions there are essentially no sales. In contrast, in some metropolitan areas BEVs appeared quite popular.</p><p class="base">Ah, but the details! In such cities BEVs qualified for a license plate at no cost and with no wait, while buying a plate for an ICE (internal combustion engine) car requires entering a lottery with average wait times of 2 years, and paying up to $12,000 in fees. The BEV exemption thus provides a huge implicit subsidy – but the BEV quota is finite. In one major city the quota of 50,000 was quickly filled. Total BEV sales: 50,800. Absent subsidies, there's as yet no market for BEVs in China, and these subsidies are not set to expand. At the national level they are already shrinking, and there's no systematic rollout of charging infrastructure. Instead, we have owners dropping wires from the window of 5th floor apartments to let them charge their cars. <span class="aside">[There were a couple news stories last year on this, if I can find the links I'll edit them into this post.]</span> So while China may be the largest single BEV market, that's due to a confluence of idiosyncratic and transient subsidies, not to effective policy or consumer demand.</p><p class="base">So in the end the EU will be first. What is not yet know is whether battery prices will fall sufficiently to become competitive with ICEs. After all, ICE costs are also falling – a decade ago, did anyone foresee "real" cars running on 3-cylinder engines? Lower component count aside, those save weight in a manner that batteries don't, and so allow downsizing in suspensions, frames – everywhere! – with attendant cost reductions. No current commercial battery technology can offer those indirect savings. Even if things go well, it will still be well into the 2030s before EVs will comprise half of sales in development markets. By that time biofuels will also have advanced. My own belief is that in 2030 we'll see a variety of drivetrains coexisting in the global market, with variations in dominant power sources from country to country.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/figS2XhUeYE" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/07/germany-will-be-first-in-evs-but-dont.htmltag:blogger.com,1999:blog-2959361113187475098.post-32412265599483207752017-06-23T02:26:00.003-04:002017-07-09T10:47:51.800-04:00Airlib', and Uber All is Over: ridehailing & carsharing aren't viable businesses<p class="signature">Mike Smitka from Brunate, Italy</p><p class="dblin">Sorry for the sorry attempt at a pun, but I had my normal 4-week Spring auto seminar that included a week with students in Detroit and daily classes. The closing week included two two-hour Skype sessions with co-blogger David Ruggles, fit in between his guitar lessons while he remained home in Las Vegas. Then came the <a href="https://www.industrystudiesconference.org/program">Industry Studies Association</a> conference (where I presented a paper on why there will be no disruption in the auto industry in terms of new entry, but already has been in OEM profits). Then it was off to the <a href="http://gerpisa.org/">GERPISA</a> global auto industry conference in Paris, where I gave two presentations in two sessions, moderated a third session and took part in a meeting of the organization's steering committee, 4.5 days of work. My wife accompanied me to toot around, and then we headed to Germany (my brother was finishing a month in <a href="https://en.wikipedia.org/wiki/Freiburg_im_Breisgau">Freiburg</a>), are now high above Lake Como at the top of the <a href="http://www.funicolarecomo.it/">funicolare</a>&nbsp;above the city, and leave this morning for the southern end of Lake Lucerne for a day en route to the Zurich airport and home. OK, enough with excuses that I'm sure elicit tears of sympathy.</p> <p class="base">On to higher topics: Uber. The firm's death spiral should now be visible for all to see. I'm not thinking of the firing of the founder by the board, but of the string of a dozen-plus executive departures, many voluntary (example: the CFO). People are fleeing the Titanic, the big players with Golden Parachutes (lifeboats would be demeaning), while tough times their plebeian drivers face are getting tougher (including loss of market share to various and sundry rivals). Investors (crocodile tears) in our latest dot.com fad are set to go down with the ship, as any hope of an IPO have surely vanished.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://4.bp.blogspot.com/-W0z_UQZS6FA/WUynt21dUwI/AAAAAAAABDk/Eu-8ABBWH7khQ_EYvL4vuXjMqLnam60FACLcBGAs/s1600/IMG_2463.jpg" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="1200" data-original-width="1600" height="240" src="https://4.bp.blogspot.com/-W0z_UQZS6FA/WUynt21dUwI/AAAAAAAABDk/Eu-8ABBWH7khQ_EYvL4vuXjMqLnam60FACLcBGAs/s320/IMG_2463.jpg" width="320" /></a></div> <p class="base">I've mentioned from time to time Airlib', a Paris "new mobility" provider. While they target a different segment from Uber, their experiment suggests wider problems with the hailing/sharing segment. Their cars are visible in residential areas of the Paris, where they have charging stations and the parking spots to go with them. (Which is more valuable, I wonder?) My wife and I watched their all-electric fleet of by-the-hour rentals come and go; they had a row of vehicles on the sidestreet of our hotel, plus we ate outside at an adjacent restaurant. On the surface they have plenty of business, families swiping their pass at a window to open a car up, and after unplugging the charger it was off on a quick shopping trip, things of that sort. There were also a lot of Airlib' staff, apparently repositioning cars to places with too few while freeing spots where users might want to drop vehicles off, and cleaning cars. But Autolib' cars are <i><b>not</b></i> clean, they're old and dingy, custom-made Pininfarina cars amidst a sprinkling of new Renault ZOEs.</p> <p class="base">Apparently the company is not doing well (conversations with Paris-based researchers, not my own research). First, that we saw a lot of Airlib' vests was not unrepresentative: their personnel costs are high. People don't treat shared cars as their own, so they need constant cleaning. That requires a car to take drivers to Airlib' parking locations, who then take them to a cleaning facility. Of course a car then needs to be sent to pick up drivers once they've returned a car to a slot. The bottom line is that the process requires two people and a car that is then unavailable for rent. The above photo is representative of what soon happens: a hub cap missing, body panels that have been repaired, an overall dirty exterior, and an interior that has seen better years (not days). One side aspect of the constant cleaning, though, is that it facilitates repositioning cars.</p> <p class="base">Second, cars remain in the fleet: custom, bare-bones electric econocars have no resale value, so need to be driven until they die – they soon look like taxis everywhere. I didn't have the keypass to get inside one, and didn't want to interrupt a family unloading groceries, but apparently the insides are worse than the outsides. Third, the rentals are short-term, too few hours to generate the expected level of revenue. Finally, from a public policy standpoint, survey data (researchers at the GERPISA conference) suggest that users would otherwise use public transport: they are not giving up cars. Airlib' does not lessen urban vehicular congestion, it makes it worse.</p> <p class="base">I also wonder about the parking spaces they occupy: do they add to urban congestion by leaving fewer free, resulting in more circling of the block in search of a spot? There's a US parallel: friends down from New Jersey report that they don't drive into the city very often, midtown is occupied by Uber vehicles. Since unlike a regular taxi they can't be hailed, they obtain no benefit from cruising the streets. Instead they park, or more properly "stand" with their drivers inside, taking up a visible share of the already sparse Manhattan parking spots. My friends are patient people, they're in to visit their architect daughter <a href="http://stephaniegoto.com/">Stephanie Goto</a>, but it's insufficient for the Uber hurdle.</p> <p class="base">One parallel business is <a href="https://en.wikipedia.org/wiki/Zipcar">Zipcar</a>. They've been acquired by Avis; I've not tried to see if that segment is broken out. Is the short-term rental business profitable? I have my doubts, but at least Zipcar is now owned by an experienced fleet management company, with "ordinary" cars that can presumably be remarketed (sold at auction) and replaced by new vehicles on a regular basis to keep them fresh in user's eyes.</p> <p class="dblin">Anyway, I have a wealth of topics coming off of the past two months, including my own preliminary presentation at GERPISA on the geography of the Chinese industry. Are producers locking themselves into high-cost production locations, driven to the provinces by industry policy – I mean, there's a car plant on the province-island of Hainan! Is Shanghai becoming a new Detroit, a center of global R&amp;D, with most global suppliers having engineering centers there? More on those issues later: I've summer research money to compile data from a 900+ page company directory. There's also notes from the GERPISA visit to Renault's R&D center, including their competitive analysis "teardown" hall (a room doesn't have enough room).</p> <p class="base">Now really, to be profitable, new ventures should focus on high-margin businesses, not low-margin ones. What do you get by disrupting the latter with an app? Low margins. Unfortunately the auto industry as a whole is a low margin business. That's why over the past 50 years there's been scant new entry: it's not for lack of imagination, it's for lack of profits to be had.<img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/eQp5rcHgXsg" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/06/airlib-and-uber-all-failure-in.htmltag:blogger.com,1999:blog-2959361113187475098.post-20575720112445713102017-05-14T14:02:00.001-04:002017-05-14T14:09:32.966-04:00Chinese assembly flow<p class="base">I'm back from a week in Detroit with students [schedule <a href="http://econ244.academic.wlu.edu/2017-schedule/">here</a>] that included factory tours at the <a href="https://www.thehenryford.org/visit/ford-rouge-factory-tour/">Ford Rouge</a> plant in Dearborn, <a href="http://www.giffininc.com/">Giffin</a> in Auburn Hills and <a href="https://www.cspplastics.com/">Continental Structural Plastics</a> in Carey, OH. Both Giffen and CSP were 2017 <a href="http://www.autonews.com/section/pace01">PACE Award</a> winners. Even though what they saw is a small sample of the range of processes in automotive parts manufacturing and final assembly, they now have a sense of what goes on.</p><p class="base">So here is a really nice video that follows a vehicle through the assembly process. During our trip we didn't see welding robots but we did see a paint shop and robots inserting/removing material from a <a href="https://en.wikipedia.org/wiki/Sheet_moulding_compound">SMC stamping press</a>. Because those were not metal parts we didn't see e-coat in the paint shop of Continental Structural Plastics in Carey, OH. We did however see the stamping of body panels, which is not shown in this video. We did see the roof liner being inserted in the Ford Rouge plant (though given the large number of things being done, students likely don't recall that one particular step). In any case much of this video should now be familiar to my students. Oh, and China is not much different from the U.S. Production in China is driven first and foremost by quality and speed considerations, not by labor costs, so robots do the welding and the heavy lifting.</p><p style="text-align: center;"><a href="https://nyti.ms/2r7gV5Q">NYTimes video</a></p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/si7ahlLO1U0" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/05/chinese-assembly-flow.htmltag:blogger.com,1999:blog-2959361113187475098.post-17589074533751304972017-05-05T13:58:00.000-04:002017-05-05T14:00:40.188-04:00LF Participation: Improvement Continues<p class="signature">Mike Smitka, Economics<br />Washington and Lee University</p><p class="callout">...how many older workers can be enticed back into the labor market?...</p><p class="base">Rather than headline unemployment rate I follow participation rates because so many would-be workers dropped out of the labor market during the Great Recession. In a couple age brackets we've now returned to normal as judged by the pre-recession average, which was roughly flat over the period 2000-2006. The black line is a moving average, which means that it lags as participation increases. The raw average is now at 99%, but bounces around a lot from month to month. I'm thus conservative in how I approach the data. While I do not correct for this (I don't have age-specific data) the share of the labor force working involuntary short hours is down to 3.3% from a Great Recession peak of 6.0%. Some of this improvement thus includes a transition from part-time to full-time work. It's taken 7 years, which means a lot of personal pain and sidetracked careers. But most of the slack in labor markets has now disappeared.</p><p class="base">Of course these data are national averages, so there will be a lot of local variation. One caution: participation by older workers at near historic highs. The aging of the baby boomers means there are many people wanting jobs who a generation ago would have been fully retired. How many of them can be enticed back into the labor market? We'll find out over the next couple years. In the meantime, if labor markets really are tightening, then we should start to find employers offering higher wages to attract and retain workers, first on a regional level, then nationally. I however don't follow those data. I need to start reading the Federal Reserve <a href="https://www.federalreserve.gov/monetarypolicy/beige-book-default.htm">Beige Book,</a> which provides the qualitative impressions of Fed staff in each of its 12 districts.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://2.bp.blogspot.com/-KBCjucZywC0/WQy7IDlIcnI/AAAAAAAABCw/Pg_hplQ72p4MON_zTA1EC0kbxgiBNIxjwCLcB/s1600/ParticipationApr2017.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://2.bp.blogspot.com/-KBCjucZywC0/WQy7IDlIcnI/AAAAAAAABCw/Pg_hplQ72p4MON_zTA1EC0kbxgiBNIxjwCLcB/s1600/ParticipationApr2017.jpg" /></a></div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/rAxQvUipJ9E" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/05/lf-participation-improvement-continues.htmltag:blogger.com,1999:blog-2959361113187475098.post-79054928264621480522017-05-02T09:57:00.000-04:002017-05-02T09:57:08.074-04:00Data Point: Real Yield Curve<div class="separator" style="clear: both; text-align: center;"><a href="https://1.bp.blogspot.com/-8gySdPHR8gE/WQiNugoVGdI/AAAAAAAABCI/s7d7J_lO20E14Ng4tXDp1UPlrjYLw9b_ACLcB/s1600/RealYieldDifferential.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" src="https://1.bp.blogspot.com/-8gySdPHR8gE/WQiNugoVGdI/AAAAAAAABCI/s7d7J_lO20E14Ng4tXDp1UPlrjYLw9b_ACLcB/s320/RealYieldDifferential.jpg" width="480" height="348" /></a></div><p class="base">Periodically I've posted graphs showing the future bond yields implied by the difference between (say) the yield on a 5 year bond and a 7 year bond. The Treasury also issues <a href="Treasury Inflation-Protected Securities">TIPS</a>, bonds whose post-inflation yield is guaranteed. Doing so gives suggests after-inflation returns – the yield on a 2-year bond – of 0.65% in 2022. Over the past 10 years, as per the previous post, real bond yields lay below the real growth rate by about 0.65%. So will the ceiling on real growth over the next 5 years be 1.5%?? This of course is consistent with the <a href="http://econpapers.repec.org/RePEc:nbr:nberwo:19895">argument of Robert Gordon</a> that the US is seeing and will continue to see lower growth than experienced in the first four post-WWII decades. (For reference I also include one measure of inflation, the rate of increase in personal consumption expenditures after lopping off items with the highest and lowest price changes. This continues to trend just under 2%.)</p><div class="separator" style="clear: both; text-align: center;"><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=dztt" imageanchor="1" style="clear: right; float: right; margin-top: -0.2em; margin-left: 1em;"><img border="0" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=dztt" width="430" height="223" /></a></div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/wKxfXj4sbkQ" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/05/data-point-real-yield-curve.htmltag:blogger.com,1999:blog-2959361113187475098.post-79713211310552571972017-04-30T23:43:00.000-04:002017-04-30T23:54:42.299-04:00US Deficits and Sustainable Debt<p class="base">As Congress and the Trump Administration begin to work on their fiscal program, with the potential for tax cuts and expenditure increases, it's important to think about whether our current deficit is sustainable. Now Japan is fast approaching a point where debt issues will overwhelm their financial system. <span class="aside">(My senior capstone read a paper by Hoshi &amp; Ito<sup class="note" style="color: green;"><b>Note</b></sup> that lays forth that case, arguing that the breakdown point will occur by 2027.)</span> The US is not Japan: we have a growing population, less debt, and smaller deficits. Nevertheless at some point we too will need to put our fiscal house in order.</p><p class="callout">...we don't need to run a surplus, but the current deficit isn't sustainable...</p><p class="base">What follows uses a simple (but standard) arithmetic framework to clarify what matters. As long as debt to GDP is stable, we should be OK, because the demand for financial assets grows with the economy. In general institutional investors such as pension funds hold government bonds for good reasons, and that a particular bond has matured doesn't change that. So they want to buy new bonds to replace the old. In other words, at today's level of debt, the Treasury can "roll over" debt, issuing new bonds to replace old. There's not only no need to repay our debt, financial markets would be hard-pressed to find alternative assets if we did so. <span class="aside">Indeed, 20 years ago, under the impact of the Clinton administration's budget surpluses, Federal debt was declining rapidly and there was hand-wringing about how financial markets could function if all the debt was repaid. Some of that public worrying was partisan, used by those who wanted to argue that large tax cuts were OK.</span></p><p class="base">Our economy is also growing. So even if the absolute amount of debt continues to rise, potentially debt to GDP will not. Indeed, that's what happened following WWII. By the end of the war <a href="https://fred.stlouisfed.org/series/FYPUGDA188S">debt surpassed GDP,</a> but fell to just over 20% by 1974. This didn't happen because we ran budget surpluses. Quite the contrary, on average we ran small deficits after 1948. But we did grow, enough to outgrow our debt. But today we're running significant deficits and not growing. </p><p class="base">Interest rates matter. In the 1950s and 1960s they were relatively low, so the interest the Treasury paid on our debt didn't offset growth. Today we again have low interest rates, but we also have low growth. So we need to ask whether that changes the situation.</p><p class="base">Again, what we want to look at is whether debt is stable relative to GDP. That is, if B is the stock of bonds and Y is GDP, is B/Y growing? On its own – assuming bonds are rolled over – the stock grows with accumulated interest: <sub>t+1</sub> = B<sub>t</sub>(1 + i), where B<sub>t</sub> is the stock of bonds at time t and i is the nominal interest rate. Similarly, GDP grows at Y<sub>t+1</sub> = Y<sub>t</sub>(1 + g) where Y is nominal GDP and g is the nominal growth rate. Hence debt to GDP will grow at: </p><div style="line-height: 0.98em; margin-left: 40pt; padding: 0;"><u>B(1+i)</u><br />Y(1+g)</div><br /> To put this to use, we need three pieces of information: what is the level of debt, B/Y; what is the growth rate g;, and what is interest rate i. That will give us an indication of whether debt is sustainable, and if not, what level of surplus is needed to keep it within bounds.<br /><p class="base">The first is easy: Federal debt is approximately 100% of GDP, that is, debt to GDP ratio is 1.0 – convenient for arithmetic, as multiplying by 1 is easy. We then need to know the ratio (1 + i)/(1 + g). When i and g are single digits in percentage terms, as in the US, that ratio is approximately 1 + i - g. In other words, with our debt ratio of 1, B/Y will shrink as long as (1 + i - g) is less than 1. The critical issue then is the value of (i - g). If i &gt; g then our debt level will rise, unless we run surpluses. If i &lt; g then we can run (small) deficits indefinitely, as happened during 1949-1974, yet not see our debt level rise.</p><p class="base"><div class="separator" style="clear: both; text-align: left;"><a href="https://1.bp.blogspot.com/-WOLSm87-VtU/WQJPVkE-jRI/AAAAAAAABBI/c18i-Ivpz6cwYyLDxtxqbCzErJWYzH4gACLcB/s1600/R-G.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" height="232" src="https://1.bp.blogspot.com/-WOLSm87-VtU/WQJPVkE-jRI/AAAAAAAABBI/c18i-Ivpz6cwYyLDxtxqbCzErJWYzH4gACLcB/s320/R-G.jpg" width="320" /></a></div>Now while it might seem that we ought to be able to earn better than the growth rate, this is fundamentally an empirical question. Thanks to the Great Inflation of the 1970s and 1980s nominal interest rates and nominal growth varied wildly. But real growth and real interest rates stay within fairly narrow bounds, except at the depths of our recent Great Recession. The graph below sets forth those data. Excluding the peak around 2009 we find that the average level of (i - g) is about -0.6%. If we include the peak, the average is roughly 0. Now as the graph below indicates, real long term bond yields fell over the past 15 years and are now on the order of 0.8%. Investors, rightly or wrongly, have not built strong growth into bond prices. So to date there's no evidence that the Fed's ongoing normalization of interest rates will raise real interest rates relative to growth. If so, we can run deficits of 0.6% of GDP forever.</p><div class="separator" style="clear: both; text-align: right;"><a href="https://1.bp.blogspot.com/-lxOif3yQ-64/WQJPXZCpizI/AAAAAAAABBM/zBa1p7UQ0p0mTWY_SMUfMw96KZKVf5kxACLcB/s1600/RealYieldCurve.jpg" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" height="232" src="https://1.bp.blogspot.com/-lxOif3yQ-64/WQJPXZCpizI/AAAAAAAABBM/zBa1p7UQ0p0mTWY_SMUfMw96KZKVf5kxACLcB/s320/RealYieldCurve.jpg" width="320" /></a></div><p class="base">To reiterate, we don't need to run a surplus. However, we do need to bring the budget close to balance. Unfortunately, our current deficit is about 3% of GDP. Now that's a vast improvement over the -10% of GDP level at the trough of the Great Recession. Employment growth and profit growth led to stronger income tax receipts, while the improved employment situation led to a drop in "safety net" expenditures. That combination lowered the deficit by a full 7% of GDP. Unfortunately we can't expect further gains, as profits are now high and (un)employment low. There is however downside potential. So we ought to count on the deficit averaging out at -3.5% of GDP, not -3.0%. </p><p class="callout">...that means we need to "enhance revenue" by 4% of GDP, not cut taxes...</p><p class="base">That does not factor in the aging of the baby boomers, who haven't fully retired and whose healthcare expenses will continue to rise until offset by rising boomer mortality. Such retirement-related expenses will likely come to at least 1% of GDP. Hence we need a fiscal adjustment on the order of 4.0%-4.5% of GDP. Congress needs to "enhance revenue," not cut taxes.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=dxWN" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="298" src="https://fred.stlouisfed.org/graph/fredgraph.png?g=dxWN" width="640" /></a></div><p class="blogcomment">Note: Hoshi, Takeo, and Takatoshi Ito. 2014. “<a href="http://econpapers.repec.org/article/blaecpoli/v_3a29_3ay_3a2014_3ai_3a77_3ap_3a5-44.htm">Defying Gravity: Can Japanese Sovereign Debt Continue to Increase without a Crisis</a>?” <i><b>Economic Policy</b></i> 29(77): 5–44.<img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/pYsgJog2ryg" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/04/us-deficits-and-sustainable-debt.htmltag:blogger.com,1999:blog-2959361113187475098.post-7812176119548067302017-04-26T01:47:00.001-04:002017-04-26T01:47:48.351-04:00Tesla: First the Cash, Then the Crash<p class="base">Tesla recently (briefly) surpassed both Ford and General Motors in market capitalization. My own prognosis for Tesla's longer-run prospects aside, once the Model 3 launches cash flow will improve markedly. Financial markets may interpret that as validation of the high price they've put on Tesla shares. That however is a predictable result of the nature of cash for an automotive assembler, and will have nothing to do with Tesla itself. But it does mean that you shouldn't short Tesla yet.</p><p class="callout" style="padding-right: 100pt">...you shouldn't short Tesla yet...</p><p class="base">Why do I believe this will happen? As our alumnus Bill Cosgrove emphasized in him many visits to Econ 244, in up cycles car companies spin off stupendous amounts of cash. In down cycles they're cash incinerators. Let's examine one source of that (there are others).</p><p class="base">Historically dealerships financed the biggest asset in the auto industry, the inventory that sits on their lots. In particular, they pay for cars as they roll off the assembly line. (To be precise, dealerships' banks pay for them via the financing of "floor plan".) Suppliers contributed, too, because they are paid 90 days in arrears. In the early years of the industry they were the biggest cost of production. From the 1920s that role diminished, as Ford and General Motors integrated vertically into making their own engines and frames and bodies. But over the last 25 years car companies systematically spun off their internal parts into standalone operations, Delphi in the case of GM and Visteon in the case of Ford. So paying suppliers in arrears is again qualitatively important. Now when sales increase, for example up 2% in the month, car companies then take in 2% more cash, but pay out nothing more. It's only after 3 months do the payments to suppliers start to rise. That process continues as long as sales rise, irrespective of underlying profitability. A rising tide raises all ... wait, that's not the right image.</p><p class="base">Or maybe it is. Because at some point the tide goes out, and with it goes the cash flow. The process reverses. Now car companies are taking in less money, but they're paying out the same amount or – if sales were rising and not just flat – amounts that will continue to increase for 3 months. Worse, it often takes a while to react, as a car company you don't want to slow production because of one odd month. And so the factory pushes metal onto dealership lots. As sales continue to fall, inventory piles up, and at some point the dealers push back, and stop ordering cars. In other words, inventory adjustment amplifies the pace of the downturn. Cars companies burn through cash. They turn from printing presses of profits into incinerators of money.</p><p class="base">So when the Model 3 launches, Tesla will report a significant improvement in cash flow. Tesla investors will get good news for a few quarters, as the first 100,000 cars roll off the line and make their way into the garages of the more well-heeled of the enthusiasts who laid down their $1,000 advance deposit. This shift in finances will appear to validate the case for Tesla's high stock price.</p><p class="base">But sales can't keep rising forever, particularly as Tesla will only have this one new model, and in a market where consumers are shunning sedans. At that point Tesla will begin hemorrhaging cash. They will have to pay suppliers more and more even as revenue stagnates and then falls. Worse, because they don't have independent dealerships, their debt will also explode as inventories build up. They won't be able to cut output fast enough, because they will have to keep paying suppliers for the higher level of orders prevalent 3 months earlier. They won't be able to cut sales staff, either, if they want to stay in business. Unlike traditional dealerships, their stores won't have service revenue, because most Tesla's will be new. That will be made worse by the nature of their product, as there won't be the oil changes that help service operations generate profits for dealerships even when car sales tank.</p><p class="callout">...don't short Tesla – <u>yet</u>...</p><p class="base">So don't short Tesla – <u>yet</u>. But that time will come, because of the nature of the auto business.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/l-YmguGS7Vc" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/04/tesla-first-cash-then-crash.htmltag:blogger.com,1999:blog-2959361113187475098.post-53273351982524012502017-03-26T10:09:00.000-04:002017-03-26T10:21:47.871-04:00NPR Marketplace: When it comes to NAFTA and autos, the parts are well traveled<p class="signature">Mike Smitka<br />Washington and Lee University</p><p class="base">On the Friday 24 March NPR Marketplace did an extensive story on automotive parts and NAFTA. For the show, go to <a href="https://www.marketplace.org/2017/03/24/world/when-it-cones-nafta-and-autos-parts-are-well-traveled">When it comes to NAFTA and autos, the parts are well traveled</a> on the Marketplace website.</p><p class="base">Scott Tong put together the story, with travel to Ann Arbor. The story that aired featured extended pieces of interview with Dave Andrea of CAR (the Center for Automotive Research) and with Michael Smitka of Washington and Lee University. Scott did a very good job addressing a complex topic.</p><p class="base">This is part of a longer Marketplace series <a href="https://www.marketplace.org/topics/nafta-explained">NAFTA explained.</a></p><p class="econ244" style="text-align: justify; margin: 0 50px;">For the interview with me Scott was actually sitting in the back seat of the Honda CRV that he discussed with David. Scott skyped me on my computer, I recorded it on my iPhone and then sent the audio files to him. That process worked well, though I had on headphones to lessen feedback which in retrospect probably didn't improve the sound that much, but did make it harder for Scott to piece together the specific questions he was asking as there was no recording of that.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/Ld9xs-ZoXm4" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/03/npr-marketplace-when-it-comes-to-nafta.htmltag:blogger.com,1999:blog-2959361113187475098.post-51658378319881779132017-03-18T16:35:00.001-04:002017-03-18T16:35:19.052-04:00Oil Prices and Trucks and ICEs: Implications for Tesla's Model 3<p class="base">As emphasized in Chapter 11 of Smitka & Warrian (up on Amazon Jan 1st!), battery electric vehicles (BEVs) offer many efficiency benefits relative to vehicles powered by an ICE (internal combustion engine). However, this benefit comes with an up-front cost premium that means that, absent subsidies, they fail to provide a value proposition to purchasers. There is no evidence that will change by 2020. </p><div class="separator" style="clear: both; text-align: center;"><a href="http://www.energypost.eu/wp-content/uploads/2016/04/Schalk-Cloete-figure-2.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" src="http://www.energypost.eu/wp-content/uploads/2016/04/Schalk-Cloete-figure-2.png" width="320" height="160" /></a></div> <p class="base">One aspect is that ICEs continue to improve. A quick glance at the <a href="http://www.autonews.com/article/20161008/OEM10/310109988/30-finalists-vie-for-pace-awards">Automotive News PACE Awards finalists for 2016-17</a> shows that 11 of the 34 innovations up for this year's awards improve ICE efficiency. <span class="aside">(Winners will be announced in a black-tie event at the Fisher Theater in Detroit on Monday, April 3rd, just before the start of the big annual Society of Automotive Engineers convention. Yours truly will be in attendance.)</span> So while the cost of battery packs continues to fall, and density to increase, they face a moving target. Turbochargers are widespread, start-stop systems are more robust, parasitic losses are being cut as electric motors replace hydraulics, and variable compression systems are starting to launch. </p><p class="aside">...this is not the time to be launching a new sedan...</p><p class="base">Furthermore, there's some indication that the current approaches to Li-ion chemistry are reaching their limits, though the best lab technologies are years from commercial production so incremental improvement will continue apace. Similarly, economies of scale in cell and battery pack are less than expected, evidenced by the construction of multiple small plants. My reading is that costs bottom out around 100,000 vehicles worth of battery packs a year. Now today no single model is at that point, but that day is not far off. Furthermore, <a href="https://qnovo.com/110-fools-overture/">battery margins aren't great</a>, so it's not as though car companies pay exorbitant prices. </p> <p class="base">In other words, manufacturing isn't like internet businesses, where up-front development is a significant part of overall costs and hence every additional user improves profitability. Elon Musk is a victim of the old and mistaken Stalinist belief that bigger is always better. In contrast there are only a handful of "fine chemical" producers, which is where DOE analysis suggests the profits lie. But that's not the end of the business that Tesla is in, nor is it the focus of the battery joint ventures of Nissan and others. </p> <p class="base">That leaves two markets for electric vehicles: the luxury end, where price does not dominate the purchase decision, much less fuel efficiency. There other is as a "compliance car" made to satisfy one or another regulatory constraint. </p> <table style="float: right; border: 3px; margin: 10px;"><tr><td>Model</td><td>Announcement</td><td>Delivery</td></tr><tr><td>Model S</td><td>June 2008</td><td>June 2012</td></tr><tr><td>Model X</td><td>Feb 2012</td><td>Sept 2015</td></tr><tr><td>Model 3</td><td>July 2014</td><td>? late 2017 ?</td></tr></table><p class="base">Tesla did very well in the $100K end of the market. Rather than supporting the Model S with a full redesign, Musk is instead moving downmarket. Slowly. After all, the company has limited engineering resources, and so can only come out with a new car once in 3 years. (They are promising an earlier date for the Model 3.) Unlike Jaguar, which will use the experienced contract assembler <a href="http://www.autonews.com/article/20170317/COPY01/303179966/magna-may-invest-up-to-1-3-billion-to-open-slovenia-car-plant">Magna Steyr for the 2018 launch of its I-Pace electric SUV</a>, Tesla insists on going it alone. That eats up capital it could better use to replace its high-end product, and results in slow and late launches, replete with quality glitches.</p> <p class="base">So what will the market for the Tesla Model 3 be like? The bottom line is, not very good. First, direct subsidies are under attack (though what if anything the current US administration will actually do defies prediction). That is critical for sales of the Model 3, because sales targets transcend the volume the luxury market can generate. Then there are ZEV emission credits and more generally a car's contribution to meeting CAFE restriction. Tesla can't itself use ZEV credits; they need to sell them. And because they sell no fuel-gulping pickup trucks, what happens to CAFE is not directly relevant. Indirectly, though, the launch of the GM Bolt cuts into the ZEV market, and Trump's promised relaxation of CAFE requirements will shift the overall market even further away from the sedan segment. (Using BEA data, in Feb 2017 trucks ran at 11.2 mil SAAR, cars at 6.3 million.) This is not the time to be launching a new sedan, and Trump is promising to make the market less favorable. California is important enough to GM that they need to sell Bolts there to let them sell more high-margin SUVs and pickups. The compliance car market is not relevant for Tesla. </p> <p class="base">Then there are gas prices. Saudi Arabia would like OPEC to cut output, but is in no position to do so unilaterally. It provides subsidies to keep its population (and ever-larger royal family) happy, and is running a deficit. It desperately needs revenue, but with only a 10% share of the global market – and US tight shale output staying stubbornly high – a cut in output results in a less-than-proportional rise in price. Even with inelastic demand (say, -0.3), revenue falls. So it needs to keep pumping. Nor are US drivers helping, as <a href="https://www.bloomberg.com/news/articles/2017-03-16/opec-can-t-count-on-american-drivers-to-help-boost-oil-prices">Bloomberg points out</a>. That makes it even harder to sell a BEV on the basis of their savings on gasoline purchases.</p><p class="aside">..Tesla investors are set to learn the hard way...</p><p class="base">Now I've no doubt that the Model 3 will be a nice car, though even if it does carry a $35,000 list price, you won't be able to find one that isn't loaded. Since on the basis of history there's every reason to believe that initial production volumes will be quite low, we'll be regaled with stories of high demand, cars snapped up as fast as they can be produced. But can they sell 100,000 in 2018? I doubt it, and a mid-sized car in the volume segment won't deliver high margins in a market where everyone wants a truck. Meanwhile the Chevy Bolt will have been out for a full year, the Nissan Leaf updated and BEV subsidies in China pared. Tesla will have to be very generous on the trade-ins they accept to keep sales flowing. They can bury that in their financial statements for a while. Those in the auto industry know how that ends. Tesla investors are set to learn the hard way.</p> <p class="base"><span class="aside">note that Tesla just raised an additional $1 billion in cash</span></p> <p class="base">bibliography</p><p class="biblio">Chung, D., Elgqvist, E., & Santhanagopalan, S. (2016). <a href="https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=0ahUKEwifiKDZ8eDSAhVK7SYKHU5SB_wQFgggMAE&url=http%3A%2F%2Fwww.nrel.gov%2Fdocs%2Ffy16osti%2F66086.pdf&usg=AFQjCNEeE6gyfSen3wE7ONMtojBzu1jWIQ&sig2=FwdPbHFO7MkLiFShveEcSA&bvm=bv.149760088,d.eWE">Automotive Lithium-ion Battery (LIB) Cell Manufacturing: Regional Cost Structures and Supply Chain Considerations</a> (No. NREL/PR-6A50-63354 Prepared under Task No. VTP2.6B01). CEMAC (Clean Energy Manufacturing Analysis Center).</p><p class="biblio">Martin, R. (2016). <a href="http://ezproxy.wlu.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=118880405&site=ehost-live">Why We Still Don’t Have Better Batteries.</a> MIT Technology Review, 119(6), 22–22.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/zpIz3K0MHdw" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/03/oil-prices-and-trucks-and-ices.htmltag:blogger.com,1999:blog-2959361113187475098.post-78606226667825633362017-03-16T13:35:00.000-04:002017-03-16T13:35:42.189-04:00Intel + Mobileye: Strategic Sense, Financial Nonsense<p class="signature">Mike Smitka<br />Prof of Economics, Washington and Lee University</p><p class="base">Cars employ more and more processing power, from chips that handle keyless entry and kick-to-open functions to engine controls and now ADAS (Advanced Driver Assist Systems). Someday there may even be autonomous vehicles, requiring GPUs (graphics processing units) to interpret sensor data and powerful CPUs to run the algorithms. Intel has a very small automotive footprint, having been in and out of several segments over the past 3 decades, at one time making engine control modules for Ford, and buying Wind River, which had projects with BMW and Magnetti Marelli. As the computer and server markets mature needs to develop a wider footprint. At a broad level the Mobileye acquisition could serve as an entrée into the automotive sector, bringing systems capabilities for interpreting vision data that would bring instant access to most global automotive OEMs and major Tier I integrators such as Delphi.</p><p class="callout">...automakers would welcome a stronger Intel presence...</p><p class="base">The automotive end would welcome a stronger Intel presence as well. Over the long haul, no car company wants to be tied to a single provider. Intel rivals are moving. In 2015 NXP acquired Freescale, now Qualcomm is acquiring NXP. That combination will have over $30 billion in revenue. Renasas and Infineon are out there, too, and in individual niches there are players such as NVDIA for GPUs – that ADAS thing – and infotainment systems. Major automotive players would love to have another strong player that they can pull into development projects.</p><p class="base">One challenge is execution: Intel has $60 billion in revenue, Mobileye perhaps $300 million. By reputation Intel tends to swallow up small companies, but not digest them and spread their know-how into the larger organization. Selling into the automotive footprint is not easy, with long lead times, complicated and very idiosyncratic test requirements (your cell phone won't work if it's been out in the desert sun, or put through engine compartment vibrations for a month). Mobileye knows how to do that, and could ease Intel's reentry. They also understand the software and data flows in a vehicle system; selling a stand-alone chip is an uninteresting business. Intel needs to add value by bringing to the table a palette of software tools and interface capabilities that let it provide systems-level solutions. Thus it is important that Mobileye not be split up and spit out. The deal has it remaining a subsidiary based as now in Israel, rather than trying to move it (which means its key personnel) to the US. Instead Intel will move people there. Automotive customers will need convincing that this arrangement isn't temporary, and Intel will have to learn how to tap Mobileye's automotive knowledge. That won't be easy.</p><p class="callout">...the acquisition makes strategic sense...</p><p class="base">So the acquisition makes strategic sense, even if there are non-trivial barriers to successful execution.</p><p class="base">It does not make financial sense. Rounding so as to make the arithmetic easy, Intel has a P/E of 15. To pay back the $15 billion up-front price, they thus need to generate $1 billion in profits. That won't happen immediately, so we're implicitly doing a net present value calculation. Thus we should ask whether in 2025 the acquisition will be generating $2 billion in profits. (I used a 15% discount rate; assuming Mobileye is making $100 million, this requires that profits increase at an 80% annual rate.) Now maybe that can happen. Both Intel and Mobileye have fat profit margins, so in principle the combination will need to add incremental revenue of $8-$10 billion. But reaching that level will require continuing high levels of up-front investment, call it research. Unlike with making a chip, it will also require continuing R&D, here with an emphasis on the development side of the equation. This isn't like developing a chip, where all the costs lie up front, and the profits flood in once sales commence.</p><p class="callout">...yet Intel investors should be hearing a warning BZZZ...</p><p class="base">Furthermore, the automotive development cycle is long. For all the hoopla about autonomous vehicles, we're looking at a few hundred experimental cars on the road globally in 2020. If that goes well, work will begin on real cars that will launch in the 2025 timeframe. But they will still be high in cost, and the market uncertain. (At the rate Uber and its ilk are losing money, they won't be customers.) Volume, if any, won't come until 2030 and beyond. The holy grail that will make cars a shell for expensive software systems run on expensive hardware will remain out of reach in a timeframe relevant even for patient investors.</p><p class="base">In contrast, ADAS is already here. What isn't known is how well received it will be as it moves downmarket. There also remain major problems with the human interface. Drivers can't zone out on the interstate while lane-keeping and adaptive cruise control are engaged, and then just pop back in when there's a warning signal. The systems have to be fail-safe, or more accurately lawyer-proof. Yes, car manufacturers can try to force a driver to keep their hands on the steering wheel. The immediate market is commercial trucking, and in that footprint Intel has already purchased Peloton Technologies (not Peloton, the exercise equipment company!). However, that segment won't generate sufficient revenue to justify the price being paid for Mobileye. In the passenger setment, the rollout of ADAS technologies has been most aggressive in Europe, which is a more technology-friendly in its regulatory and legal system. Vehicle margins in the EU are thin. The big and profitable vehicle markets are NAFTA and China. In Asia, urban congestion and aggressive (random!) driving habits make the ADAS consumer value proposition challenging: when cars move, the warning systems would be producing a constant BZZZ. </p><p class="base">Intel investors should be hearing a warning BZZZ, too.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/C6roqlE75wQ" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/03/intel-mobileye-strategic-sense.htmltag:blogger.com,1999:blog-2959361113187475098.post-55182748608520105272017-03-14T10:45:00.000-04:002017-03-20T18:17:26.342-04:00Musk’s Facts Are Wrong (Maryann Keller guest post)<p class="signature">Maryann Keller<br />Principal at Maryann Keller & Associates LLC</p><p style="text-align: center; font-size: 110%;"><b>Musk’s Facts Are Wrong Regarding the Termination of NUMMI Joint Venture</b></p><p style="text-align: center;">Published on February 11, 2017 on LinkedIn<br /><span class="aside">cross-posted with permission</span></p><p class="base">In response to Tesla workers at its Fremont, California assembly plant contacting the UAW to possibly seek out representation, Elon Musk responded that the former GM-Toyota NUMMI joint venture, at the same facility Tesla occupies today, was closed because it was a UAW plant and therefore not competitive. In fact, there is nothing further from the truth and his claim is likely due to the oft-prevailing view of the UAW’s role leading to General Motors’ bankruptcy. </p> <a name='more'></a><p class="base">A little background about this plant located in the Bay Area of California. Originally built as a GM assembly facility in 1961, it would operate for some 20 years until GM ended the plant’s operation in 1982. Through most of that period, particularly through the 1970s, the plant was notorious for poor quality and terrible labor relations. But the plant would come back to life in the mid-1980s as a joint venture assembly plant between GM and Toyota called NUMMI (New United Motor Manufacturing Incorporated).</p><p class="base">General Motors and Toyota each had their own reasons for entering into the joint venture. GM believed that by giving operating control of the plant to Toyota, the Japanese company would reveal its manufacturing secrets to GM, especially in automation. GM convinced Toyota to accept the closed plant in Fremont as GM’s contribution to the venture and rehire some of the plant’s previously laid off workers.</p><p class="base">Toyota, at the time, was under great pressure to reduce U.S. imports from Japan and had already agreed to voluntary import restraints. This made production in the US inevitable for the Japanese automakers but, Toyota, being a very conservative company, worried that it could not implement the Toyota Production System in the U.S.; American automotive labor was blamed for low productivity and poor build quality. Without incurring the costs of building a new plant, the existing Fremont plant could be brought into production relatively quickly thus solving a problem for Toyota in its search for new U.S.-located capacity. My knowledge of this deal between GM and Toyota for NUMMI is quite intimate; my husband negotiated the deal between the companies for more than a year to come up with a working solution for both parties. </p><p class="base">My book, <a href="https://smile.amazon.com/Rude-Awakening-Struggle-Recovery-General/dp/0688075274/">Rude Awakening</a>, details the NUMMI experience but to summarize, Toyota decided to hire some ex-GM workers and train them in the Toyota Production System. The plant had its own UAW contract which was repeatedly renewed without a single strike and did not include many of the provisions of the UAW national agreement with GM. NUMMI quality was on a par with that of Toyota plants in Japan and the positive labor experience emboldened Toyota to establish its massive manufacturing footprint in the Midwest and Southeast.</p><p class="base">The NUMMI message for Toyota was that it was not the American workers - even those organized by the UAW - who were to blame for GM’s productions pitfalls, but rather GM management that failed to train and share responsibility for results with the factory work force. But it would also prove that California, with its myriad of regulations at all government levels, tough environmental requirements, and high cost of living could no longer compete by the mid-2000s with the generous financial incentives and ease of doing business offered by other states for automotive manufacturing. </p><p class="base">Over time, GM took less and less of NUMMI production and by the 2000’s had effectively withdrawn from NUMMI. By then, Toyota assembly and supplier capacity was concentrated nearly two thousand miles away in lower cost locales. NUMMI became an isolated outpost that had lost its relevance to the two partners.</p><p class="base">Both companies needed a reason to withdraw; ironically both partners used the GM bankruptcy to end the relationship. Tesla then got the plant for much less than its true value. NUMMI was terminated because it simply was no longer relevant to either partner.</p><p class="base">Toyota successfully operated NUMMI with unionized labor for 25 years. The message, therefore, from NUMMI, is not whether the plant is unionized but rather how management engages with, trains, supervises, and values its hourly employees. Elon Musk is simply wrong to blame the closure of NUMMI on the UAW.</p><hr width="60%" align="center"><div class="blogcommentmore">In fact all the plants west of Kansas City were closed by the time NUMMI was set up, including those in British Columbia. At a slightly slower pace the same pattern is found on the East Coast where all factories were closed (such as the Ford truck plant in Norfolk VA for which a number of plants in my rural region made parts). The same was true of suppliers. And the same was true in Europe. Today, as detailed in the work of <a href="https://www.chicagofed.org/publications/economic-perspectives/2015/4q-klier-rubenstein">James Rubenstein and Thomas Klier</a>, the industry is concentrated in an "auto corridor" or "auto alley" which minimizes shipping distance to consumer markets, and improves manufacturing logistics. When NUMMI was set up Toyota was relatively weak in the midwest and imported a wide array of parts from Japan. By the time it closed, its sales reflected the overall US market; a location on the West Coast made no sense, or rather cost dollars. Ditto for parts imports: today the overwhelming majority of vehicles Toyota sells in NAFTA are made in NAFTA using suppliers based in NAFTA. From that perspective a midwest location was also desirable. <span class="aside">mike smitka</span></div><div class="blogcommentmore">An interesting note is that John Krafcik, now president of Waymo [the Google autonomous car project] and previously President of the US arm of Hyundai, among other jobs, was a junior GM staffer assigned to NUMMI. That story forms the core of his MIT MBA master's thesis, when he was part of the International Motor Vehicle Project "The Machine That Changed the World" project. Among other contributions to that book, Krafcik was the one who coined the term "lean production." Back to NUMMI: when he and others assigned to the joint venture returned to GM they were scattered across the organization and any impact they might have had was diffused. That's one reason he moved on.<span class="aside">mike smitka</span></div><div class="blogcommentmore">I also know the (long-retired) GM executive who negotiated the benefits component of the NUMMI contract. Labor relations at the old GM plant were stormy, not the least because of plant management – those familiar with labor issues are well aware that a bad start due to poor plant-level management could poison labor relations for decades. NUMMI allowed a clean start, and under new management and without the baggage of history Toyota and the UAW got along well. In other words, the problem lay with GM at the plant level, made worse by the winding down of the branch plant system noted above.<span class="aside">mike smitka</span></div><div class="blogcommentmore">Written by <a href="http://www.linkedin.com/in/maryann-keller-4ab1a15">Maryann Keller</a>, Principal at <a href="http://www.maryannkeller.com/">Maryann Keller &amp; Associates.</a> Go to linked in for <a href="https://www.linkedin.com/pulse/musks-facts-wrong-regarding-termination-nummi-joint-venture-keller">the original post.</a></div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/DPYTP5nAJ3Q" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/03/guest-post-musks-facts-are-wrong.htmltag:blogger.com,1999:blog-2959361113187475098.post-54622273740355097042017-03-07T00:45:00.002-05:002017-03-20T18:17:07.086-04:00Ride Sharing (Maryann Keller guest post)<p class="signature">Guest Post, Maryann Keller, Principal at Maryann Keller &amp; Associates LLC and Ken Elias</p><p class="blogcommentmore">David Ruggles speaks regularly with Maryann Keller; we cross-post from LinkedIn with her permission. She is the single most highly regarded auto industry analyst, and has sat on the boards of rental car companies (and was president of priceline.com) so has a good understanding of the economics of ride sharing in one of its "traditional" segments. David took her on her first UBER ride in Washington DC in February 2016. She's since done research on this new "disruptor." They do huge business but lose money doing it. What can be their end game? </p><p class="title" ><b>Ride-sharing Apps: Low Fares Can’t Last</b><br />Published on March 6, 2017</p><p class="base">It’s no secret that Uber, Lyft and other ride-sharing apps offer fares less than taxis; exactly how much less depends on metro area, time of day, and ride length. Lower fares, the ease of using the app to summon a car, and cashless payments have built a large user base for the dominant players, Uber and Lyft. But with both companies losing hundreds of millions of dollars a quarter, how soon will investors demand a path to profitability? (<a href="http://techcrunch.com/2016/12/21/uber-losses-expected-to-hit-3-billion-in-2016-despite-revenue-growth/">TechCrunch.com</a> reports that sources suggest Uber lost three billion dollars last year!)</p> <a name='more'></a> <p class="base">Silicon Valley-supplied capital often funds disruptive business models that require subsidizing users to gain market share or influence partners. During our early days at priceline.com, Ken Elias and I saw the company establish itself by using investor money to purchase airline tickets at retail prices and then resell them to consumers below the company’s cost. However, rapid consumer acceptance of <a href="priceline.com">priceline.com</a>’s opaque pricing model helped prove to the airlines that enough consumers were indifferent to the airline and departure time in return for a lower fare. The subsidies proved the case; airlines could see the power of the internet to fill unsold seat inventory without destroying their posted fares under the priceline.com program. Airlines soon provided priceline.com with special “hidden” fares thus allowing the start-up company to eliminate the subsidies and earn profits on ticket sales. </p><p class="callout">...enjoy the low fares while you still can...</p><p class="base">While conceptually Uber, Lyft and their clones are using the same strategy, there are significant differences that might produce results very different from the priceline.com airline (and hotel) experience. Underpricing a service to buy market share only works if there are levers in place to find ways to lower expenses, which in the case of priceline.com did happen when hotels and airlines provided lower pricing for expiring inventory. Or, alternatively with other examples, consumers become hooked on a service – such as with DirectTV – and are willing to pay more for it after the expiration of subsidized trial offers.</p> <p class="base">In the case of ride-sharing companies, the market price that equates to profitable operation has already been determined by the taxi industry. Why? Because whether it’s a taxi company, a limo service, or Uber or Lyft, every ride requires a car and a driver. Gasoline, vehicle depreciation, insurance, and maintenance are a given in all cases and they are identical irrespective of the provider. There are costs to driving every mile with or without a fare. For the airlines, there is a fixed cost to making every flight whether the plane is full or empty; selling unsold seats at even lower prices than published, but at a price consumers cannot see and must make tradeoffs to get, just adds to the marginal revenue of the flight. </p> <p class="base">Ride-sharing app companies promote their services for individuals to earn additional income as drivers. Use your own car to make extra cash is an appealing proposition in one sense. But these drivers may be financially unsophisticated individuals who might account for their activities on a cash basis until they realize that the added miles reduce the value of their vehicles while accelerating maintenance. Depreciation is the single largest expense for any vehicle fleet operator but it is not realized in cash terms, so to speak, until the vehicle is disposed. Because ridesharing drivers use their own vehicles, pay for all gas and maintenance, and ultimately bear the expense of depreciation, the remaining dollars, including necessary accruals, represents their actual income which is less than the cash received from net fares. </p> <p class="base">It is more than likely – and recent evidence suggests – that the drivers are catching on to the real costs of driving what is effectively a taxi – but not achieving their expected income. High turnover among drivers suggest that many individuals ultimately realize that the economics don’t work at current fare levels. In effect, these drivers are subsidizing the ride-sharing services too. </p> <p class="base">The <a href="http://www.bloomberg.com/news/articles/2017-02-28/in-video-uber-ceo-argues-with-driver-over-falling-fares">recent video exchange</a> between Travis Kalanick, CEO of Uber and Fawzi Kamel, an UberBlack driver, highlights the plight of the drivers – fares have fallen (due to competition from other app ride services) only because investors and drivers are willing to subsidize fares. It’s certainly not because there’s a way to lower the costs of vehicles and drivers. </p> <p class="base">Actual data from a <a href="http://sharespost.com/downloads/SharesPost-Ride-Sharing-Uber-Lyft-Research-Report.pdf">Sharepost report</a> demonstrate this. The analyst who wrote the report actually became an Uber driver for a short stint. He claims to have driven 11 hours for UberX and received $225 in total compensation or roughly $20 per hour. </p> <p class="base">He drove 175 miles for UberX around the San Francisco Bay region. For argument’s sake, using the <a href="http://www.irs.gov/uac/2017-standard-mileage-rates-for-business-and-medical-and-moving-announced">IRS’ standard mileage deduction</a> for 2016 at $0.54/mile, which includes variable and fixed costs for an automobile, his vehicle costs for the trips totaled $94.50. Effectively, he netted only $130.50 for his time or $11.86 per hour which is less than the minimum wage in San Francisco ($13 per hour). And no mention is made or attributed to the costs of driving excess mileage to return to his home base or driving empty. Worse, the government reimbursement rate per mile is likely too low since it reflects a national figure for an “average” vehicle; mileage costs are probably higher in major urban areas.</p> <p class="base">There is no way to eliminate the fixed and variable costs of delivering transportation in vehicles piloted by hired drivers. And these costs are comparable to that of taxi companies. Uber and Lyft cannot reduce these costs since they are determined by the nature of the business. Fares will have to rise to adequately compensate the drivers (and eventually the investors in the ride-share app companies as well).</p> <p class="base">As we wrote <a href="http://www.linkedin.com/pulse/who-owns-cars-move-autonomous-vehicle-ride-sharing-maryann-keller">previously on LinkedIn</a>, fully autonomous vehicles are not a solution, and they will wreck the app-based companies’ balance sheets. While an auto manufacturer might produce these vehicles for purchase, the manufacturer will not want to take on the financial obligations of owning and maintaining that fleet. Even assuming that the ride-sharing company could find a fleet management company to own and maintain the cars, that fleet provider would price its service to make a good return on investment. This is something the individual ride-sharing driver probably doesn't consider at first and is therefore likely not reflected in current rates.</p> <p class="base">While Uber, Lyft, and other mobility apps in the U.S. gain traction with consumers, one might believe that once again, Silicon Valley (or its subsets in other big metro markets) has again wisely invested and created untold value from little more than a modern ride demand/supply matching system. But without investor subsidies, and drivers willing to make less than minimum wage, fares can only rise to those comparable with taxi companies, if not even higher.</p> <p class="base">Consumers should enjoy the low fares while they still can.</p> <p class="blogcommentmore">Written by <a href="http://www.linkedin.com/in/maryann-keller-4ab1a15">Maryann Keller</a> and <a href="http://maryannkeller.com/ourpeople/ken-elias/">Ken Elias</a> of <a href="http://www.maryannkeller.com/">Maryann Keller & Associates</a></p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/SsgXflMSlVA" height="1" width="1" alt=""/>David Ruggleshttp://www.blogger.com/profile/04354349511843594159noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/03/maryann-keller-on-ride-sharing.htmltag:blogger.com,1999:blog-2959361113187475098.post-14475264105180257492017-02-25T15:33:00.001-05:002017-02-25T15:33:29.341-05:00Peak Auto (III): Global Margin CompressionA teaser, not yet written, but do see parts I and II below!<img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/YfjNdF8tbG0" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/02/peak-auto-iii-global-margin-compression.htmltag:blogger.com,1999:blog-2959361113187475098.post-19435861999199281932017-02-25T14:17:00.001-05:002017-03-17T11:11:03.541-04:00Peak Auto (II): Tesla Valuations<p class="signature">Mike Smitka</p><p class="base">My previous post looked at frivolous investments by assemblers as evidence that's we're at the peak of the automotive cycle. Of course that doesn't mean that we're heading into a trough, just that there's not much upside. Investors in Tesla ought to take that to heart. The company sold about 80,000 vehicles last year in a 90 million unit global market (order of magnitude) that's growing by over 3% (again, a round number). That translations into 2.7 million incremental units a year, the equivalent of 11 new standard 240,000 unit annual capacity assembly plants. From a global perspective, Tesla isn't even a rounding error. In the $100,000+ performance car market they're more of a player, but Tesla's rivals are all launching their own battery-beefed-up or full-battery performance vehicles. Those rivals have global distribution and service networks in place, too. So if Tesla is to expand it must be in the volume segment end of the business.</p> <a name='more'></a><p class="callout">...investors [are] reading more profits into the industry than it can feasibly generate...</p><p class="base">So what will Tesla need to accomplish, besides <a href="http://seekingalpha.com/article/4049370-tesla-capital-raise-now-bankruptcy-4-months">not running out of cash</a>? Their financial statements show that for all the talk of solar cells and batteries, they remain an automotive company in revenue and operating costs. So on that basis, their long-run P/E should reflect that reality. Here is what the industry looks like:</p><div style="margin-left: 40px; font-size: 0.8em; line-height: 0.8em;"><table width=90%><tr><td width=15%>Firm</td><td>Symbol</td><td>P/E ratio</td><td>Market Value</td><td>Revenue (quarterly)</td></tr><tr><td>GM</td><td>GM</td><td>6</td><td>57</td><td>44</td></tr><tr><td>F</td><td>F</td><td>11</td><td>50</td><td>39</td></tr><tr><td>FCA</td><td>FCAU</td><td>9</td><td>17</td><td>30</td></tr><tr><td>Toyota</td><td>TM</td><td>11</td><td>168</td><td>83</td></tr><tr><td>Honda</td><td>HMC</td><td>15</td><td>56</td><td>43</td></tr><tr><td>Nissan</td><td>NSANY</td><td>9</td><td>38</td><td>27</td></tr><tr><td>PSA</td><td>PUGOY</td><td>11</td><td>17</td><td>14</td></tr><tr><td>Renault</td><td>RNLSY</td><td>8</td><td>27</td><td>13</td></tr><tr><td>BMW</td><td>BMWYY</td><td>8</td><td>59</td><td>23</td></tr><tr><td>Daimler</td><td>DDAIY</td><td>9</td><td>78</td><td>41</td></tr><tr><td>VW</td><td>VLKAY</td><td>[+140!]</td><td>77</td><td>58</td></tr><tr><td>Tesla</td><td>TSLA</td><td>[negative]</td><td>42</td><td>2.3 (2.0 automotive)</td></tr><tr><td style="background-color: #FFFFFF;"><b>Average</b></td><td>&nbsp;</td><td style="background-color: #FFFFFF;"><b>10</b></td><td>&nbsp;</td><td>&nbsp;</td></tr></table></div><p class="blogcommentmore">Source: Yahoo! Finance; financial statements for Nissan. I did not include VW's P/E in calculating the industry average.</p><p class="base">Some of these companies have recent negatives, others recent positives. So the average of about 10 should be a good indicator. On that basis Tesla needs to generate $4 billion in profits. If we assume, very [very!] generously, that they can manage a 10% profit margin on sales then they need revenue of $40 billion [Ford earned 3.3% globally in 2016Q3, down from 7.7% in 2015Q3]. What will Model 3 give them? US sales of 250,000 units a year are highly optimistic, given sales of other vehicles in that segment, and Tesla has little infrastructure in other big markets. Exporting 250,000 a year isn't going to happen. Expanding their domestic US sales and service network will eat into margins, too. But let's buy into the bullish story, and assume they can actually sell 300,000 units in 2018 at $40,000 per car. That's still only $12 billion. Add in other models and there's maybe another $8 billion, assuming gratuitously that sales of those aging models don't sag despite new entrants. [In point of fact, <a href="http://files.shareholder.com/downloads/ABEA-4CW8X0/0x0x913801/F9E5C36A-AFDD-4FF2-A375-ED9B0F912622/Q3_16_Update_Letter_-_final.pdf">sales of existing models are flat</a>.]</p><p class="base">So they're a growth story – but they won't start producing the Model 3 in volume until 2018. [Tesla has yet to host journalist test drive shindigs yet – with the automotive journalist motto "drink free or die" those are rightly called drive-and-drink weeks. Anyway, those are 6 months before production, and with a new model and a new plant ramp-up then can't be earlier than 2018.] If they have a followup model that will add volume, then it can't be any time before 2021, as they've yet to raise money for a new assembly plant, much less break ground. But by then they'll be needing to launch Model 3a, because staying competitive in the volume segment requires periodic updates.</p><p class="base">In short, any additional growth for the Model 3 won't be until sometime in the 2020s. After all, in visiting suppliers as a judge for the latest round of the Automotive News PACE competition, MY2019 was mainly a done deal, with firms working on their order books for 2020 and beyond. Tesla has said nothing about commencing development work on a Model 5, or whatever they hope next to do.</p><p class="callout">...autos aren't rocket science, they're much more challenging...</p><p class="base">Now there are lots of downsides. No other car company has seen fit to get into the battery business, and lock themselves into a particular technology. The flip side is that other auto companies don't believe that economies of scale will prove the key to lowering costs. More important is for <a href="http://wardsauto.com/industry/lg-chem-details-cell-making-process-michigan-plant">suppliers such as LG Chemical to utilize capacity</a>. In that case, Tesla has no particular advantage in selling battery packs for home users and utilities. Tesla's solar panels are again a strictly US play, don't have a monopoly and face regulatory hurdles in sunshine states such as Nevada. And then there's the Tesla's historic inability to launch their automotive products on time and on cost. Finally, Tesla can't count on ZEV credits adding $3,000 a vehicle as total output rises, because the size of that pot will shrink over time as other companies launch compliance cars in California. Elon Musk has yet to demonstrate a golden touch when it comes to designing, developing, making and selling physical products. That's not his forte: autos aren't rocket science, they're much more challenging.</p><p class="base">Meanwhile Faraday Motors seems to have bitten the dust; <i>de novo</i> entrants to the auto industry have not fared well this past half-century. I do expect a couple to survive in China, perhaps Great Wall, but dealership challenges plague many players, including Audi and BMW. (For more on that see <a href="https://smile.amazon.com/Profile-Global-Auto-Industry-Innovation-ebook/dp/B01MS2ALIU/">my book</a>! The room for error in the car industry is narrow, the potential to make big mistakes is wide.</p><p class="base">So we're seeing peak auto not just in car companies having more cash than they know what to do with. We're also seeing investors reading more profits into the industry than it can feasibly generate.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/BhcAsVxXM40" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/02/peak-auto-tesla-valuations.htmltag:blogger.com,1999:blog-2959361113187475098.post-9496606247724818582017-02-21T14:59:00.000-05:002017-03-17T11:10:49.596-04:00Peak Auto (I): Frivolous Investments Rise<p class="signature">Mike Smitka, Prof of Economics<br />Washington and Lee University<br />Co-author <b><i><a href="https://smile.amazon.com/Profile-Global-Auto-Industry-Innovation-ebook/dp/B01MS2ALIU/">The Global Auto Industry: Innovation and Dynamics</a></b></i>, 2017.</p><p class="base">The auto industry is at peak. The best indicator lies not in the sales numbers, but in the behavior of the OEMs. Flush with cash, they are again buying businesses peripheral to their core operations, such as ride sharing services.</p><p class="callout">...car companies frittering away cash is the best indication of peak auto...</p> <a name='more'></a><p class="base">OEMs are fixed-cost businesses. The design and engineering of cars and engines chews up piles of cash. Assembly plants need someone at every work station, whether they are are busy making cars, or merely trying to look busy. Workers on the line thus are likewise a fixed cost. So when sales plummet, companies bleed red ink. Likewise when sales are strong, car companies spin off incredible amounts of cash.</p><p class="base">The problem at the peak of a cycle is what to do with all that money. Executives know that they ought to save it for the inevitable rainy day, but as publicly traded companies they find that hard to do. Instead they buy things. In previous up cycles the Detroit Three all acquired aerospace firms – for GM it was Hughes Aircraft. They built new R&D centers, such as FCA's [Chrysler's] showcase Auburn Hills (Michigan) complex. They purchased banks. They got into the rental car business – Hertz was Ford's play in that footprint. They added brands, too, from Hummer and Saab to Ford's Premier Automotive Group that included Volvo, Jaguar and others.</p><p class="base">Europe and Japan are no different. Under Jürgen Schrempp Daimler accumulated a wide array of businesses, in aerospace, heavy trucks, and mass-market cars [Chrysler and Mitsubishi Motors]. VW stuck mainly to motor vehicles, but they also got into the heavy truck industry, and picked up smaller companies such as SEAT and Škoda and superluxury marques including Lamborghini and Bentley <span class="aside">(at the time VW wrongly thought they were getting the Rolls-Royce brand as part of the deal, in a hasty deal emblematic of "peak auto.")</span> In Japan less money went into unrelated businesses, though Toyota builds houses and boats. Instead they proliferated models and brands. For example, Mitsubishi Motors and Mazda, the smallest of Japan's Big Five, both added multiple marques ("channels" in Japanese parlance) in the 1980s; MMC's Diamante luxury marque lasted a little over a dozen years, consuming resources their core products and dealers sorely needed.</p><p class="base">Car companies likewise forget their rental car company history to their detriment. They were never good at fleet operations, which involve running branches at airports and in cities small and large, all while balancing fleet size over the course of a year, and carefully watching acquisition price versus the residual wholesale auction value as a used car some months later. That's a very different set of skills than those needed to design, manufacturer and sell vehicles over the four- to six-year-long cycle of a full model change at an OEM.</p><p class="base">At one time Ford owned Hertz, Chrysler had Dollar Thrifty, General Motors held a stake in Avis, and first Renault and then VW controlled Europcar. In Japan dealership channels have captive rental operations, but the market however is dominated by Nippon Rent-a-Car and Orix, owned respectively by an airline and a leasing company. In Japan, Europe and the US the car rental industry has consolidated into fewer players, including in the US the acquisition of Budget/Thrifty by Enterprise.</p><p class="base">Car companies came to realize that for a rental agency to make money, they had to buy base models at wholesale prices. Having a captive rental firm as a customer thus tended to depress, not raise, OEM margins. While in the short run car companies could push vehicles into rental fleets to keep factories running, that led to operating losses at the rental car companies. It wasn't hard to see through that game, even if the details could be buried in financial statements. Furthermore, rental fleets hold cars for less than a year, so in short order pushing fleet sales depressed used car prices and ate into retail margins. Over time all who have tried have retreated from that business. </p><p class="base">So why has GM spent $500 million on Lyft? That have no need to do that to sell vehicles, even if (contrary to current experience) "New Mobility" businesses become significant purchasers of new vehicles. After all, GM can already sell all the vehicles they want to Enterprise, which is the world's largest single purchaser of cars, to the tune of over 1 million units a year. <span class="aside">(To GM's credit, they've avoided boosting market share by selling discount vehicles to Enterprise and their peers.)</span></p><p class="base">Ride hailing services are fundamentally fleet businesses. Now Uber, Lyft and others have found creative ways to arbitrage the rules that gave cab companies local monopolies. <span class="aside">(Zipcar and Autolib' are different: they operate in urban center rental car niches that were not well serviced by Enterprise and other traditional providers.)</span> To maintain the superior level of performance they promise, Uber for example needs to have lots of cars on the road, with drivers for each. In other words, they will increasingly come to operate their own fleet of vehicles, directly or indirectly, however much they claim to be unlike traditional taxi companies and car rental firms. It's certainly not a business car companies need to be in.</p><p class="base">Such uses of cash thus reflect typical "peak auto" behavior. It's a silly investment strategy. Today high tech stocks are pricey, while the need to unload will be greatest in a recession when such assets won't fetch much. GM will get dimes on the dollar. While that's better than having no cash at all, GM's balance sheet isn't like it was in 2007. A recession won't push them into junk bond territory.</p><p class="callout">...it's sad that simply holding cash isn't viewed as an option...</p><p class="base">What we are seeing is thus an old story, money burning holes in pockets. Balance sheets are flush, and CEOs won't catch flack from their boards for buying into the "sharing" economy and the push to make autonomous vehicles. Indeed, executives likely face pressure from their Boards to get into these trendy businesses. It's sad that simply holding cash isn't viewed as an option.</p><p class="base">The typical way to assessing peak auto looks to sales trends. Now with sales at a rate of 17+ million units there's scant room for an uptick in volume or profits in North America. There's margin compression in China. The volume vehicle segment in Japan is so perennially unprofitable that Ford has closed their operations, while GM believes Europe is similar and so are selling their (unprofitable) European operations, once the continent's largest. Reading those tea leaves likewise suggests we're at a peak. To me, though, car companies frittering away cash is the best indicator.</p><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/il64UCdbod4" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/02/peak-auto-frivolous-investments-rise.htmltag:blogger.com,1999:blog-2959361113187475098.post-43261061354237386332017-02-04T08:52:00.001-05:002017-02-04T12:41:02.747-05:00Review: The Bug Movie<p class="signature">Mike Smitka</p><p class="base">T<i>he Bug Movie: Life and Times of the People's Car</i> Produced and Directed by Damon Ristau, Co-Produced by Jason Willenbrock and Tory Alonzo. Chassy Media, November 2016. $14.99 Downloand/DVD, $17.99 BluRay. Available at <a href="https://www.chassymedia.com/product/the-bug/">https://www.chassymedia.com/product/the-bug/</a>.</p><div class="blogcommentmore">Publisher's Description: The Bug Movie is a feature length documentary film about the most recognizable and beloved vehicle on the planet: The Volkswagen Beetle. From its dark past in pre WWII Germany, to the Summer of Love, this car captured the hearts of millions of people worldwide. This film explores not only the history of this automotive icon, but also the intense emotional connection it has with its owners past and present… Including Ewan McGregor and his experience with his first VW Bug as a sixteen year old.</div><p class="base">I am not a "car guy." My drives have never had a nickname, and seldom get cleaned. The rusted through body panels on my 1988 pickup truck are going to get more rusted. My son can point out cars of note on the opposite side of the freeway. I'm not sure what a Tesla looks like. I live close enough to Hershey, PA that I could visit the classic car fest come October. Indeed, as a member of the Society of Automotive Historians I receive an invitation to their dinner there. I've yet to make it. For me this documentary was thus an introduction to the culture of car buffs, in this case those in love with the classic VW Beetle. Three sorts are depicted in vignettes that develop over the course of this video. Some grew up with memories of it as the family vehicle; for others their strongest memories came through The Love Bug and the other five Disney Herbie films in which a 1963 Beetle was the star. Some just like fixing up old things. Restoring a Beetle to working order is feasible: so many were made that parts remain readily available.</p> <a name='more'></a><p class="base">The story that runs throughout and helps tie this documentary together begins with hauling a Beetle out of the garage where it had sat for two decades, after the man who was fixing it up passed away. His widow and her son deliver the partially disassembled car, replete with parts wrapped in paper, to an enthusiast. The first stage is cleaning out packrat debris, and then pushing it from the storage shed onto a trailer. Over the subsequent year it is brought back to life, step by step: fixing up the engine and clutch, painting, and finally starting the car for the first time in 23 years. The film concludes with the new owner fulfilling his promise, driving back to show the pristine-appearing car to the old woman and her son. There are similar, shorter segments. One focuse on a man who loved the Herbie films as a kid. He eventually tracks down #10 of the 26 "expendable" vehicles used in filming the Love Bug, first in the series. It proudly sits on display, replete with the dings it received in a stunt for the film.</p><p class="base">I'm interested in the history of the industry, and there's a bit of that, with shots of the Beetle from the its origin in the 1930s to the end of its use as the standard taxi in Mexico. That story ends with the camera panning a hedgerow of Beetles awaiting the crusher, all an identical green, one of which is "saved" by an enthusiast who carts it back to the US. Likewise there's material on the arrival of the car in the US, from 2 in 1949 to 163 in 1950. However, there's no systematic analysis of the company, of the VW parallel to Ford's focus on a single model that led both companies close to failure. We get a little bit on what distinguished the Beetle from less successful small cars. There are hints of its global spread, but other than scenes from Mexico there's no treatment of how – again like the Model T – it came to be produced in multiple countries. Likewise the "pad" (in modern parlance, rolling chassis) was, as with the Model T, adapted to serve as a truck, a tractor and as the classic dune buggy. There's little on the production aspect, of the implementation of rigid automation in Wolfsburg, nor is there any discussion of Ford-like vertical integration into parts production. So while there are tidbits for those with other interests in the industry, the documentary really is by, for and about enthusiasts.</p><p class="base">One takeaway for me were sequences where enthusiasts reflected upon their infatuation. Two noted that their passion was not really rational, restoring an old car that they wouldn't drive much, and that furthermore wasn't so old or unusual as to be fit for a museum. Another noted that working on an old car was a change of pace, something he could do for an hour by himself; yes, he liked VWs, but critical was the practicality of it. They were built to be endlessly repaired, and doing so doesn't requiring having a specialized machine shop. Puttering around, yes, but with the feasible goal of actually getting the car at hand back on the road. My family never had a second car, nor a spot where my brothers and I could have worked on a "junker." I don't have the skills needed, but I certainly can understand the attraction of fixing things up.</p><p class="base">My most vivid memory of a Beetle is developing moderate hypothermia en route back to my Harvard dorm from my first cross-country skiing trip. I was shivering uncontrollably by the time we arrived; with four of us in the car we'd had to periodically open windows to defog the windshield. It was a robust design, but very much a German one, unsuited to extremes of temperature. Images of quirkiness and cuteness pervade the documentary. Design shortcomings dominate my memories; I'll never be an enthusiast. This documentary added to my knowledge of Volkswagen, particularly its history in the US market, and with footage from its early history in Germany. Most important, it has helped me appreciate a bit better the mind of the enthusiast.</p><div class="blogcommentmore">See another mention of this documentary at <a href="http://jalopnik.com/the-bug-movie-documentary-about-the-volkswagen-beetle-i-1788687334">jalopnik.com</a></div><img src="http://feeds.feedburner.com/~r/AutosAndEconomics/~4/KCiPipSUksw" height="1" width="1" alt=""/>Michael Smitkahttps://plus.google.com/105638009779168678052noreply@blogger.com0http://autosandeconomics.blogspot.com/2017/02/review-bug-movie.html